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THE  EXAMINATION 


OF 


INSURANCE  COMPANIES 


A  Series  of  Talks  to  the  Members  of  His 
Office  Staff 


BY 

S.  HERBERT  WOLFE,  F.  S.  S. 

Consulting  Actuary 

Author  of  "Inheritance  Tax  Calculations,"  "Modified  Premiums 

and  Costs,"  Etc. 


NEW  YORK 

THE   INSURANCE   PRESS 
1910 


t^&',1 


<30 


'/■/ 


^cO 


Copyright,  igio,  by 
S.  Herbert  Wolfe 


J.   B.  LYON   COMPANY 

PRINTERS  AND  BINDERS 

ALBANY,   N.   Y. 


PREFACE 


On  numerous  occasions  the  members  of  my  office 
staff  have  evidenced  a  desire  to  consult  reference 
books  which  would  enable  them  to  obtain  information 
on  points  connected  with  their  examining  and  their 
auditing  work;  my  inability  to  direct  them  to  proper 
sources  of  information  led  me  to  institute  a  system  of 
brief  talks  upon  the  topics  connected  with  their  work. 

During  the  summer  of  1910  I  was  asked  by  the  New 
York  State  Civil  Service  Commission  to  participate  in 
the  oral  examination  of  candidates  for  the  position  of 
Assistant  Examiner  of  the  Insurance  Department  of 
the  State  of  New  York.  Many  of  the  aitswers  given  by 
the  candidates  indicated  the  same  need  for  informa- 
tion which  had  been  expressed  by  my  own  assistants. 

Department  and  company  officials  to  whom  I  hap- 
pened to  mention  these  facts,  suggested  the  advisa- 
bility of  putting  these  talks  in  some  permanent  form, 
so  that  they  could  be  of  use  not  only  to  the  members 
of  my  own  staff,  but  to  Departmental  Examiners  and 
to  assist  the  accounting  departments  of  companies  in 
the  solution  of  the  numerous  problems  which  arise  in 
connection  with  their  annual  statement  work. 

In  conformity  with  that  suggestion,  I  offer  this  book 
to  those  who  may  need  it,  and  wish  merely  to  state 
that  it  was  not  my  intention  to  prepare  a  learned 
treatise  on  the  practice  and  theory  of  supervision  and 
accounts,  but  merely  to  give  to  my  fellow-workers  the 

[3] 


211710 


4  Preface 

benefit  of  the  rules  which  I  have  found  advantageous 
in  the  large  number  of  examinations  and  audits  with 
which  I  have  been  connected.  It  will  be  noted  that  it 
has  been  my  attempt  to  impart  the  knowledge  by  sug- 
gestion rather  than  by  direct  statement.  In  this  way, 
the  reasons  for  the  various  treatments  have  been  de- 
veloped and  the  logic  of  the  situations  has  been  shown 
more  clearly. 

Whenever  it  became  necessary  in  my  talks  to  refer 
to  specific  statutes,  the  sections  or  parts  of  sections 
applicable  were  read ;  I  have  reproduced  them  in  this 
book  in  the  form  of  appendices  rather  than  to  cumber 
the  text  with  extensive  quotations. 


S.  Herbert  Wolfe. 


165  Broadway,  New  York,  N.  Y., 
December,  1910. 


TABLE    OF  CONTENTS 


PAGE 

Preface 3 

CHAPTER  I. 
The  development  of  supervision  —  Personal  attitude  of  the  examiner  — 
Qualities  he  should  possess  —  His  attitude  towards  ofl&cials  of  company 
under  examination 9 

CHAPTER  II. 

Limitation  on  real  estate  holdings  —  Examination  of  title  —  Title  insur- 
ance —  Purchases  from  officers  or  interested  parties  —  Methods  of 
appraisal  —  Certificates  of  extension 16 

CHAPTER  III. 
Mortgages  —  Limited  to  percentage  of  value  of  property  —  Abstract  — 
Appraisal  —  Fire  insvu-ance  poHcies  —  "  Purchase  money  mortgages  " 
—  Notice   to   mortgagor  —  Guaranteed   mortgages  —  Transfer   of   tax 
lien 22 

CHAPTER  IV. 
Bonds  —  Different  forms  of    bonded   indebtedness  —  Railroad  bonds  — 
Registered  and  coupon  bonds — Directors  not  to  be  interested  in  sales  or 
purchases  —  Evidence  of  ownership 30 

CHAPTER  V. 
Difference  between  bonds  and  stocks  —  Danger  in  stock  investments  — 
Preferred,  common  and  guaranteed  stocks  —  Collateral  loans  — "  Win- 
dow dressing  "  —  Collateral  loans  contrasted  with  poHcy  loans 38 

CHAPTER  VI. 
Cash  in  ofiice  and  in  bank  —  Percentage  of  cash  to  invested  assets  —  Cer- 
tificate from  banking  institutions  —  Interest  bearing  and  non-interest 
bearing  accounts  —  Pohcy  loans  —  Liens  and  their  sources  — Premium 
notes 46 

CHAPTER  VII. 

Miscellaneous  assets  —  BiUs  receivable  —  Furniture  and  fixtxires  — 
Accrued  interest  —  Rent  paid  in  advance  —  Reinsurance  due  —  Agents' 
balances  —  Deferred  premiums — Uncollected  premiums  —  "Paid  for" 

and  "  written  "  bases  —  Uncollected  assessments  of  fratemals 53 

16] 


6  Table  of  Contents 

CHAPTER  VIII.  PAGK 

Loading  on  uncollected  and  deferred  premiums  —  Disallowed  or  non- 
admitted  assets  —  Loans  on  capital  stock  —  Supplies  and  printed 
matter  —  Commuted  commissions  —  Cash  advanced  to  officers  — 
Excess  credits  —  Depreciation  in  securities  —  Premiums  outstanding 
more  than  ninety  days  —  Appreciation 63 

CHAPTER  IX. 
Amortization  of  bonds  piu-chased  above  par  —  Accumulation  of  bonds 
purchased  below  par  —  Incorrect  methods  of  treating  premiums  and 
discounts  —  Necessary  factors 70 

CHAPTER  X. 

Liabilities  —  Net  value  of  life  insiu-ance  policies  —  Net  terminal  value  — 
Mean  reserve  —  Unearned  premiums  —  Unearned  premiums  on  marine 
policies  —  Perpetual  poUcies  —  Reinsurance 80 

CHAPTER  XI. 
Surrender  values  claimable  —  Different  forms  of  death  claim  liabilities  — 
Resisted  claims  —  Accident  and  health  claims  —  Contingency  reserve. .     89 

CHAPTER  XII. 
Fire  losses  —  Plate  glass  losses  —  FideUty  and  surety  policies  or  bonds 
distinguished  —  Inability  to  keep  track  of  issues  —  Suggested  remedies 
—  Salvage  —  Co-surety  —  Depository  bonds 97 

CHAPTER  XIII. 
Special   liabilities  —  Credit   policies  —  Definition  —  Methods   of   treating 
accounts  with  insolvent  debtors  —  Liability  poUcies  distinguished  from 
workmen's  collective  poUcies  —  New  York  and  Michigan  methods  of 
computing  reserves 104 

CHAPTER  XIV. 
Miscellaneous  liabilities  —  Special  or  advisory  board  contracts  —  Taxes 
due  or  accrued  —  Borrowed  money  —  Capital  stock  —  Sale  of  stock  in 
connection  with  life  insurance  forbidden 115 

CHAPTER  XV. 
Commissions  on  uncollected  premiums  —  Dividend  liabilities  of  life  com- 
panies —  Annual  and  deferred  dividends  —  Restrictions  placed  on 
dividends  by  New  York  statutes  —  By  Ohio  statutes  —  Items  of  divi- 
dend hability  in  statement  blank  —  Tontine  poUcies  —  Sources  of 
dividends 124 


Table  of  Contents 


CHAPTER  XVI. 


PAGE 


Departmental  examinations  not  audits  —  The  trial  balance  —  Premium 
income  —  The  two  bases  —  " Pohcy holders'  basis"  —  Various  sources 
of^nterest  —  Other  items  of  income  —  Premium  on  capital  stock 133 

CHAPTER  XVII. 

Evidence  of  disbursements  —  Voucher-cheques  —  Losses  —  Payments  in 
installments  —  Net  losses,  surrender  values  and  dividends  —  Other  dis- 
bursements —  Profit  and  loss 141 

CHAPTER  XVIII. 
Development  of  schedules  in  annual  statement  blanks  —  Analysis  and 
explanation  of  schedules  A  to  Y,  inclusive  of  Ufe  blank 149 

CHAPTER  XIX. 
Additional  schedule  for  fraternals  —  Schedules  in  blank  used  by  fidelity, 
surety,    credit    and    liability    companies  —  Detailed    classification    of 
fidelity  and  surety  risks 158 

CHAPTER  XX. 
Schedules  and  their  application  to  financial  portions  of  statement  — 
Method  of  checking  details  shown  in  schedules  with  items  in  other  por- 
tions of  statement 167 

CHAPTER  XXI. 

Excise  bonds  —  Special  feature  in  New  York  State  —  Excise  reinsurance 
agreement  —  Its  method  of  operation  —  Guaranty  of  bills  of  lading  — 
Other  forms  of  guaranteed  certificates 175 

CHAPTER  XXII. 

Limitation  of  risk  —  Logic  of  statutes  —  Limitation  as  applied  to  liability 
poUcies  —  To  credit  policies  —  Policies  in  hands  of  agents  —  Method  of 
verifying  unearned  premium  item 181 

APPENDICES. 

Appendix  A  —  New  York  Insurance  Law  relating  to  ownership  of  real 

estate  189 

Appendix  B  —  New  York  Insurance  Law  relating  to  disposition  of  real 

estate 190 

Appendix   C  —  Notice  to  be  sent  to  mortgagors 192 

Appendix  D  —  New  York  Insurance  Law  relating  to  directors  or  officers 

being  interested  in  purchases  and  sales  of  securities ....   193 

Appendix  E  —  New  York  Insurance  Law  relating  to  investments  of  com- 
panies, etc 194 

Appendix  F  —  New  York  Insurance  Law  relating  to  investmenji  of  capital  197 


Table  of  Contents 


PAQB 

Appendix  G  —  Certificate  for  verifying  bank  deposits 199 

Appendix  H  —  Sheet  for  determining  excess  credits 201 

Appendix    I  —  New  York  Insiu-ance  Law  referring  to  amortization  and 

market  value  of  securities 202 

Appendix    J  —  New  York  Insurance  Law  relating  to  the  computation  of 

the  loss  reserves  for  liability  companies 203 

Appendix  K  —  Michigan  Insurance  Law  relating  to  the  computation  of 

the  loss  reserves  for  hability  companies 206 

Appendix   L  —  Reserve  for  unpaid  UabiUty  losses 207 

Appendix  M  —  New  York  Insurance  Law  providing  for  a  contingency 

reserve 216 

Appendix  N  —  Ohio  Insurance  Law  pertaining  to  the  participation  in 

surplus  by  policyholders  of  life  insurance  companies.  ...  218 
Appendix  O  —  New  York  Insurance  Law  fixing  the  limitation  of  ex- 
penses of  life  insurance  companies 220 

Appendix   P  —  New  York  Insurance  Law  pertaining  to  the  annual  reports 

of  life  insurance  corporations 224 

Appendix  Q  —  Liabihty  loss  reserves 228 

Index 241 


THE  EXAMINATION  OF  INSURANCE 
COMPANIES 


CHAPTER  I 

The  Development  of  Supervision  —  Personal  Atti- 
tude of  the  Examiner  —  Qualities  He  Should  Pos- 
sess—  His  Attitude  Towards  Officials  of  Company 
under  Examination. 

It  is  my  intention  to  discuss  with  you,  from  time  to 
time,  certain  phases  of  your  examining  work  and  to 
lay  down  rules  for  your  guidance;  I  think  it  proper 
that  during  this,  my  first  talk,  I  should  briefly  trace 
the  history  of  insurance  examinations  in  this  country 
and  also  lay  down  some  general  principles,  rather 
than  to  deal  with  any  particular  phase  of  the  exam- 
ining work. 

Supervision  in  this  country  really  started  with  the 
idea  that  insurance  corporations,  like  other  corpora- 
tions, should  render  reports  to  the  financial  officers 
of  the  government  so  that  taxes  might  be  levied  and 
a  means  for  securing  revenues  for  the  State  thereby 
created;  the  thought  that  they  should  be  supervised 
for  the  benefit  of  the  policyholders  was  an  after- 
thought. The  insurance  departments  of  the  various 
States  in  this  country  are  gradual  developments; 
origiaally  started,  as  I  have  indicated,  for  the  pur- 
pose of  securing  reports  upon  which  taxe^  could  be 

[9] 


10  Examination  of  Insurance  Companies 

levied,  they  became  bureaus  of  licenses  established  not 
only  for  the  purpose  of  securing  revenue  from  agents' 
licenses,  but  also  for  the  prevention  of  soliciting  for 
unauthorized  companies.  That  was  probably  the  first 
step  for  the  protection  of  policyholders  by  the  various 
insurance  departments.  As  the  companies  grew 
larger  and  became  more  vital  factors  in  the  financial 
world,  abuses  crept  into  their  management,  and  of 
late  years,  probably  within  the  past  two  decades,  the 
supervision  by  the  State  authorities  has  taken  more 
and  more  upon  itself  the  question  of  eliminating  these 
abuses  and  requiring  the  insurance  companies  to  be 
administered  for  the  benefit  of  the  policyholders  along 
lines  not  only  sound  from  a  financial  standpoint,  but 
in  the  case  of  life  insurance  companies,  secure  from 
an  actuarial  standpoint. 

There  is  one  great  difference  between  a  depart- 
mental examination  and  an  examination  made  by  a 
firm  of  certified  public  accountants,  for  instance,  and 
that  is  this :  it  was  never  intended  that  a  departmental 
examination  should  be  an  audit.  It  is  impossible  for 
any  group  of  examiners  coming  to  a  company's  office 
for  a  brief  period  of  several  weeks,  or  even  several 
months,  to  properly  review  each  and  every  transaction 
which  has  taken  place  since  the  company  was  last 
examined.  The  form  of  examination,  therefore,  which 
you  will  have  to  follow,  may  properly  be  described  as 
more  of  a  scrutiny  of  the  system  and  methods  than  of 
the  details.  At  least,  the  first  part  of  an  examiner's 
work  should  be  to  familiarize  himself  with  the  sys- 
tems used  in  the  office,  to  thoroughly  trace  the  history 
of  the  various  transactions  in  order  that  he  may  find 
out  the  course  which  every  transaction  or  group  of 


Examination  of  Insurance  Companies  11 

transactions  takes  in  its  progress  through  the  office. 
This  scrutiny  will  enable  him  to  determine  whether 
there  is  anything  radically  wrong  in  the  way  in  which 
the  various  items  are  treated. 

Subsequently  it  will  become  necessary  to  ascertain 
whether  those  systems  which  have  been  prescribed  by 
the  superior  officers  have  been  properly  carried  out 
by  the  subordinates;  no  matter  how  perfect  a  system 
may  be  when  it  is  outlined  by  the  one  in  charge,  it 
must  be  apparent  that  the  results  will  not  be  accurate 
unless  the  man  to  whom  has  been  entrusted  the  duty 
of  making  the  entries,  thoroughly  understands  the 
system  and  obeys  his  instructions.  Any  discrepancies 
which  are  found  as  a  result  of  the  examination  of  the 
details,  must  be  followed  to  the  very  end  and  analyzed 
carefully.  It  will  not  do  to  dismiss  apparent  discrep- 
ancies on  the  theory  that  the  amount  involved  is  not 
large.  A  mistake  of  one  dollar  may  indicate  some- 
thing radically  wrong  with  the  entire  system  and  lead 
to  the  discovery  of  errors  of  great  magnitude. 

I  think  it  but  proper  that  I  should  refer  briefly  to 
something  of  great  importance  in  the  matter  of  exami- 
nations, and  that  is  the  personal  attitude  of  the  ex- 
aminer. A  great  deal  of  the  success  of  any  examiner 
is  going  to  depend  upon  the  way  he  comports  himself 
in  the  offices  which  he  is  investigating.  Tact  is  one 
of  the  primary  necessities  of  an  examiner;  without 
that  a  man  might  as  well  make  up  his  mind  that  he 
will  never  make  any  headway  with  his  work.  Above 
all,  there  must  be  no  antagonism  between  you  and  the 
employees  of  the  company,  if  for  no  other  tlian  selfish 
purposes ;  this  should  be  carefully  observed,  for  unless 
you  have  the  passive  assistance,  at  least,  of  those  in 


12         Examination  of  Insurance  Companies 

the  oflBce,  you  are  going  to  find  your  work  exceedingly 
hard.  Following  the  same  thought,  however,  I  think 
the  two  greatest  faults  that  an  examiner  can  possibly 
possess  are  bluster  and  self-importance.  I  know  of 
no  two  things  which  are  more  to  be  condemned  in  his 
makeup  than  these  two  which  I  have  just  mentioned. 
They  prevent  him  from  obtaining  the  maximum  good 
from  the  energy  which  he  must  devote  to  his  examin- 
ing work. 

In  connection  with  this  it  is  well  to  call  attention  to 
the  attitude  which  an  examiner  should  take  toward 
the  oflScials  of  the  company  he  is  examining;  at  its 
best,  an  examination  is  an  interruption  to  the  routine 
work  of  an  office,  and  in  view  of  this  fact  an  examiaer 
and  his  assistants  should  be  courteous  in  asking  for 
books,  information  and  the  necessary  data.  He 
should,  of  course,  be  firm  and  insist  upon  having  his 
wants  supplied,  it  being  understood  that  he  will  not 
ask  for  any  information  other  than  that  to  which  he 
is  entitled. 

It  is  almost  unnecessary  for  me  to  refer  to  the  fact 
that  no  examiner  should  accept  any  favors  from  the 
officials  of  the  company  he  is  examining;  no  matter 
how  innocent  are  the  attentions  which  are  accepted, 
there  is  a  feeling  of  obligation  created  which  must 
have  a  bad  effect  upon  the  work.  I  likewise  deem  it 
unnecessary  to  point  out  that  all  information  which  is 
obtained  in  the  course  of  an  examination  must  be  con- 
sidered as  strictly  confidential  and  must  not  be  dis- 
cussed with  outsiders  or  communicated  to  anyone 
except  your  superior. 

To  sum  up  the  mental  qualities  which  every  ex- 
aminer should  possess,  I  think  I  would  say  that  he 


Examination  of  Insurance  Companies  13 

should  attempt  to  have  the  combined  qualities  of  a 
sponge  and  filter;  the  sponge,  in  order  that  he  might 
be  able  to  absorb  all  the  information  which  comes  to 
him,  and  the  filter  that  he  might  be  able  to  separate 
the  valuable  from  the  invaluable,  retaining  the  former 
and  allowing  the  unimportant  details  to  rapidly  pass 
from  his  mind. 

There  is  a  great  temptation  on  the  part  of  examiners 
to  be  too  suspicious.  You  should,  of  course,  attempt 
to  find  a  reason  for  every  fact  which  is  presented  to 
you,  and  should  insist  upon  knowing  and  understand- 
ing the  underlying  cause  of  everything  that  comes  to 
your  attention,  but  on  the  other  hand  you  should  not 
allow  your  suspicions  to  influence  your  judgment. 
Very  frequently  entries  which  appear  wrong  to  you 
will  turn  out  to  be  perfectly  innocent.  It  is  quite  easy 
to  appreciate  that  an  entry  which  has  been  made  by 
a  man  who  thoroughly  understands  the  system  and 
has  been  studying  it  for  years,  may  present  a  strange 
appearance  to  you;  a  thorough  study  of  the  system, 
however,  together  with  explanations,  for  which  you 
should  never  be  ashamed  to  ask,  will  enable  you  to 
promptly  determine  the  correctness  of  the  process. 

There  is  another  quality  that  an  examiner  should 
possess,  but  for  the  acquisition  of  it  I  can  give  no 
rules,  viz.,  the  power  of  instinct.  I  imagine  that  every 
good  examiner  at  some  time  has  had  a  fact  presented 
to  him  which  at  the  outset  appears  to  have  something 
wrong  about  it,  but,  if  pressed  for  a  reason^he  cannot 
tell  why  his  suspicions  have  been  aroused ;  it  presents 
no  features  out  of  the  ordinary,  and  yet  he  feels  that 
there  is  something  wrong  about  it.  While  it  may  be 
impossible  to  acquire  this  sense,  a  careful  attention  to 


14  Examination  of  Insurance  Companies 

the  various  details,  and  an  analysis  of  the  different 
methods,  will  unquestionably  assist  in  the  develop- 
ment of  the  mind  along  these  lines. 

Those  in  charge  of  examining  work  should  not 
disregard  suggestions  which  come  to  them  from  sub- 
ordinates. It  is  extremely  dangerous  to  assume  that 
because  one  of  your  assistants  is  doing  routine  work, 
he  is  thereby  prevented  from  seeing  things  which  may 
be  of  extreme  importance  to  you.  Valuable  sugges- 
tions are  not  always  obtained  from  those  who  occupy 
positions  of  responsibility.  Even  an  office  boy  may 
be  able  to  give  you  valuable  suggestions;  in  the  case 
of  one  company  it  was  the  suggestion  of  an  office  boy 
relative  to  the  unusually  large  consumption  of  stamps 
which  led  to  the  detection  of  the  fact  that  the  secre- 
tary of  the  company  was  in  the  habit  of  secreting  in 
his  private  drawer  a  considerable  number  of  stamps. 
I  merely  mention  this  to  show  that  we  may  get  in- 
formation in  a  perfectly  proper  way  from  those  who 
occupy  minor  positions,  and  we  should  never  disregard 
any  information,  no  matter  how  humble  its  origin. 

As  a  final  word  I  might  point  out  that  a  good  ex- 
aminer attempts  to  obtain  his  information  by  unusual 
methods  whenever  possible.  By  this  I  mean  that  you 
should  not  content  yourself  with  employing  and  fol- 
lowing the  methods  which  have  been  used  by  the  clerks 
of  the  company;  you  should  attempt  to  secure  the 
information  in  a  way  differing  from  the  one  by  which 
the  entries  have  been  made.  You  will  thereby  be 
enabled  not  only  to  satisfy  yourself  that  you  are 
securing  the  correct  result,  but  you  will  be  able  to 
detect  errors  which  would  not  be  developed  by  simply 
following  the  work  which  has  been  outlined  by  the 


Examination  of  Insurance  Companies  15 

clerks  in  the  office.  I  recall  that  in  the  case  of  one 
company,  the  unearned  premium  account  in  its  burg- 
lary department  appeared  to  be  unusually  low ;  instead 
of  simply  confining  our  inquiry  to  tracing  the  entries 
which  had  been  made  in  the  office,  we  elected  to  treat 
the  matter  from  the  standpoint  of  cancellations  instead 
of  issues,  and  in  this  way  we  were  enabled  to  detect 
the  unusual,  improper  and  abnormal  cancellations 
which  were  being  made  in  that  office;  by  this  means 
the  amount  of  outstanding  premiums  in  the  burglary 
department  had  been  reduced  and  the  liabilities  of  the 
company  correspondingly  understated. 


CHAPTER  II 

Investments  —  Limitation  on  Real  Estate  Holdings  — 
Examination  of  Title  —  Title  Insurance  —  Purchases 
from  Officers  or  Interested  Parties  —  Methods  of 
Appraisal  —  Certificates  of  Extension. 

In  order  that  a  life  insurance  company  may  be  suc- 
cessful it  is  necessary  that  the  funds  which  it  has 
collected  from  its  policyholders,  in  excess  of  the  cur- 
rent mortuary  requirements,  shall  be  invested  in  safe 
securities  which  bear  a  certain  rate  of  interest;  the 
underwriting  departments  of  companies  transacting 
other  forms  of  insurance  have  not  within  the  past 
few  j^ears  been  uniformly  profitable  and  in  conse- 
quence the  returns  to  stockholders  and  the  increases  in 
surplus  funds  have  largely  come  from  the  investment 
profits.  I  cite  these  facts  as  an  illustration  of  the 
importance  from  the  examiner's  viewpoint  of  the  con- 
dition of  the  assets  of  the  corj^oration  which  he  is 
investigating.  I  shall  therefore  briefly  refer  to  the 
points  to  be  noted  in  the  various  forms  of  investment 
with  which  you  will  be  brought  in  contact. 

Eeal  estate  is  not  regarded  with  favor  by  many 
statutes  and  supervising  officers  as  a  form  of  invest- 
ment for  the  funds  of  policyholders;  the  holdings  in 
real  estate  of  insurance  companies  in  nearly  all  of  the 
States  are  limited  to  that  amount  which  is  necessary 
for  the  transaction  of  their  business  and  to  those  par- 

[16] 


Examination  of  Insurance  Companies  17 

eels  which  have  been  acquired  in  satisfaction  of  debts. 
(See  Appendix  A.)  If,  for  instance,  it  becomes  neces- 
sary for  a  company  to  foreclose  one  of  its  mortgages, 
it  naturally  must  take  title  to  the  real  estate  which 
is  involved.  If  one  of  its  representatives  should  owe 
the  company  some  money  it  would  be  a  hardship  to 
prevent  it  accepting  real  estate  from  the  agent  in  liqui- 
dation of  his  debt. 

The  examination  of  real  estate  parcels  must  be 
divided  into  two  parts:  first,  the  technical  or  legal 
aspects  which  are  involved  and,  second,  the  considera- 
tion of  the  matter  from  the  standpoint  of  an  invest- 
ment. It  is  advisable  to  place  the  first  part  of  this 
work  in  the  hands  of  an  attorney  or  real  estate  con- 
veyancer who  is  familiar  with  the  local  laws  affecting 
the  parcels  under  consideration,  but  as  an  examiner 
should  always  be  in  a  position  to  tell  his  assistants 
exactly  what  is  needed,  I  shall  indicate  the  principal 
points  which  should  be  examined  by  one  dealing  with 
the  legal  aspects. 

The  evidence  of  ownership  in  real  estate  is  a  deed 
of  some  kind,  but  the  fact  that  a  company  possesses 
this  deed  is  not  absolute  evidence  of  its  ownership; 
it  may  have  disposed  of  the  property  after  the  deed 
was  signed  and  the  title  could  be  transferred  without 
the  deed  being  surrendered. 

In  the  company's  possession  should  be  ai  abstract 
of  title  which  shows  the  history  of  the  parcel  under 
observation.  The  usual  starting  point  of  an  abstract 
is  the  patent  which  has  been  granted  by  some  sov- 
ereign government  or  State  and  upon  this  abstract 
will  be  indicated  the  changes  which  have  taken  place 
in  the  title  or  any  liens  which  may  have  been  recorded 
2 


18  Examination  of  Insurance  Companies 

against  it.  In  some  instances  it  will  be  unnecessary 
for  the  abstract  to  go  back  to  the  original  grant,  as 
some  of  the  legislatures  have  passed  acts  which  have 
for  their  purpose  the  curing  of  all  defects  in  titles  to 
real  estate  after  a  certain  date.  It  is  necessary  that 
the  abstract  should  be  brought  to  the  date  of  the  exam- 
ination in  order  to  show  the  ownership  of  the  parcel 
at  that  time. 

In  recent  years  there  has  been  a  development  in  the 
real  estate  field  which  to  a  certain  extent  does  away 
with  the  necessity  for  an  abstract.  Companies  have 
been  formed  for  the  purpose  of  issuing  to  purchasers 
of  real  estate,  a  policy  of  insurance  guaranteeing  the 
validity  of  the  title  of  the  real  estate  which  has  been 
acquired  and  promising  to  pay  to  the  owner  any  loss 
resulting  therefrom,  not  in  excess  of  the  face  of  the 
policy,  should  it  develop  that  the  title  was  not  good 
and  marketable  at  the  time  that  the  policy  was  issued. 
If  the  company  under  examination  should  possess  a 
policy  of  this  kind  issued  by  a  reputable  and  well- 
established  title  insurance  company,  it  is  the  usual 
practice  to  accept  that  policy  in  lieu  of  an  abstract, 
but  particular  attention  should  be  paid  to  the  excep- 
tions which  are  noted  in  the  policy  in  order  that  we 
may  observe  if  there  is  anything  there  referred  to 
which  would  militate  against  the  parcel  appearing  in 
the  assets  of  an  insurance  company. 

Passing  now  to  a  consideration  of  those  features  to 
which  the  examiner  should  particularly  address  him- 
self, instead  of  entrusting  them  to  an  attorney.  He 
should  first  ascertain  the  manner  in  which  the  title  to 
the  property  was  acquired,  whether  it  was  by  fore- 
closure or  bought  in  the  open  market.     If  the  former. 


Examination  of  Insurance  Companies  19 

was  the  foreclosure  the  result  of  bad  judgment  exer- 
cised in  the  ordinary  course  of  business  or  was  it 
caused  by  making  loans  upon  insufficient  security  to 
officers  or  mortgagors  in  whom  the  officers  were  inter- 
ested. If  the  real  estate  were  purchased  we  should 
determine  whether  the  vendor  was  in  any  way  inter- 
ested in  the  company  under  examination. 

The  question  of  the  figure  at  which  the  real  estate 
is  to  be  allowed  as  an  asset  should  now  receive  atten- 
tion. For  this  purpose  it  is  well  to  employ  two  com- 
petent real  estate  appraisers,  but  it  is  well  to  caution 
them  that  in  obtaining  a  fair  value  of  a  piece  of  prop- 
erty you  do  not  wish  to  obtain  a  value  which  would 
result  from  a  forced  sale,  for  this  would  result  in  too 
low  a  value  and  thus  do  the  company  an  injustice. 
On  the  other  hand,  it  is  equally  advisable  to  caution 
the  appraisers  that  you  do  not  desire  what  may  be 
termed  a  "  boom  "  value  for  the  real  estate;  ap- 
praisers are  usually  optimists  who  can  see  nothing 
but  the  most  roseate  future  for  property  in  their 
locality. 

Different  methods  are  employed  in  arriving  at  the 
market  value  of  large  pieces  of  property.  A  record 
of  the  recent  sales  in  the  immediate  neighborhood  is 
sometimes  taken  as  a  test  for  current  values,  but  this 
is  open  to  the  objection  that  the  sales  may  have  been 
affected  by  conditions  which  do  not  apply  to  the  par- 
cel under  observation;  it  may  have  been  necessary  to 
liquidate  an  estate  and  this  might  serve  to  lower  the 
value,  or  the  piece  which  has  been  sold  may  have 
had  some  strategic  position  or  may  have  had  some 
sentimental  value  which  would  not  be  duplicated  in 
the  piece  in  which  you  are  interested. 


20  Examination  of  Insurance  Companies 

Large  office  buildings  are  usually  appraised  by 
either  adding  the  cost  of  construction  to  the  value  of 
the  land  or  by  finding  the  net  rental  value  of  the  avail- 
able space,  which  figure  is  then  used  as  an  income 
factor  upon  which  the  valuation  is  predicated.  The 
cost  of  construction  depends  upon  conditions,  all  of 
which  are  not  properly  related  to  the  valuation  of  the 
property,  and  in  considering  the  valuation  on  a  basis 
of  rental  space  it  is  necessary  that  all  artificial  con- 
ditions should  be  eliminated. 

My  object  in  pointing  out  the  weak  points  in  each 
of  these  methods  is  to  advise  the  careful  examiner  to 
rely  upon  no  one  method,  but  to  obtain  his  results  by 
using  several  methods,  if  possible.  Should  any  wide 
discrepancy  occur  between  them  it  may  lead  not  only 
to  the  determination  of  the  true  value,  but  also  to  the 
existence  of  improper  conditions  which  will  be  re- 
ferred to  later. 

In  examining  the  appraisal  based  upon  rental  values 
we  must  use  the  expenses  of  maintenance  as  an  offset 
to  the  income.  An  analysis  of  the  items  entering  into 
this  calculation  will  enable  the  examiner  to  determine 
whether  any  disbursements  for  running  expenses  are 
being  charged  to  the  original  investment  account,  for 
in  this  way  it  is  a  comparatively  easy  matter  to  in 
crease  the  apparent  income  from  rentals  until  the 
asset  has  all  the  earmarks  of  an  extraordinarily  good 
investment.  It  is  needless  to  point  out  that  this  is 
a  temporary  condition,  the  correction  of  which  in  the 
future  will  involve  heavy  charges  to  profit  and  loss. 

If  the  company  is  occupying  any  of  the  building  for 
its  own  purposes,  you  should  determine  whether  the 
rental  which  is  charged  against  the  space  which  it 


Examination  of  Insueance  Companies  21 

occupies  is  in  proper  proportion  to  similar  rentals 
being  charged  to  and  received  from  other  tenants. 
This  phase  of  the  investigation  will  also  develoj) 
whether  the  company  is  allowing  any  of  its  tenants 
to  pay  less  than  a  fair  rental.  The  reason  for  such 
favoritism,  if  any  exists,  should  be  fully  explained  to 
the  examiner. 

A  careful  scrutiny  of  the  fire  insurance  policies 
which  are  held  by  the  company  should  be  made,  for 
in  the  case  of  destruction  by  fire  the  value  of  the  asset 
will  depend  largely  upon  the  company's  ability  to 
recover  upon  its  policies.  Whether  the  policies  have 
been  placed  in  an  admitted  company  is  a  phase  of  the 
question  to  which  the  examiner  should  devote  some 
attention. 

In  the  beginning  of  this  talk  I  referred  to  the  fact 
that  real  estate  is  a  form  of  investment  which  is 
frowned  upon  by  the  insurance  laws  in  most  of  the 
States.  This  fact  is  emphasized  by  the  requirement, 
now  very  general,  that  such  parcels  as  are  not  required 
for  the  transaction  of  the  company's  business  should 
be  disposed  of  within  five  years  from  the  time  that 
they  have  been  acquired.  In  order  that  the  effect  of 
this  requirement  might  not  be  too  harsh,  tla^re  is  a 
provision  that  the  supervising  officer  may  grant  an 
extension  of  time  should  he  be  satisfied  that  a  strict 
compliance  with  this  statute  would  result  to  the  dis- 
advantage of  the  company.  (See  Appendix  B.)  If, 
therefore,  you  find  that  the  real  estate  has  been  re- 
tained longer  than  the  statutes  permit,  certificates  of 
extension  should  be  exhibited  to  you. 


CHAPTER  III 

Mortgages  —  Limited  to  Percentage  of  Value  of  Prop- 
erty —  Abstract  —  Appraisal  —  Fire  Insurance  Pol- 
icies — '  *  Purchase  Money  Mortgages  ' ' —  Notice  to 
Mortgagor  —  Guaranteed  Mortgages  —  Transfer  of 
Tax  Lien. 

In  some  States  (New  York,  for  instance)  a  mort- 
gage is  a  lien  upon  a  piece  of  property  given  to  secure 
a  debt.  In  other  States  (Massachusetts,  for  instance) 
a  mortgage  is  a  conditional  transfer  of  property  as 
security  for  a  debt,  and  if  the  debt  be  paid  no  title  to 
the  property  passes.  In  some  jurisdictions  the  evi- 
dence of  the  debt  is  a  bond  signed  by  the  owner  of 
the  property.  In  other  States  the  form  which  the 
evidence  of  the  debt  takes  is  that  of  a  note  with 
coupons  attached,  and  the  mortgagee  simply  deposits 
these  coupons  in  the  bank  as  he  would  the  coupons  of 
a  railroad  bond.  In  some  cases  you  will  find  that  the 
owner  has  executed  a  deed  of  trust  in  favor  of  the 
mortgagee. 

As  I  pointed  out  in  the  case  of  a  real  estate  deed, 
the  mere  presence  of  the  mortgage  is  not  an  absolute 
evidence  of  the  possession  of  anything  of  value.  Until 
a  short  time  ago  in  New  York  a  mortgagor  could  pay 
his  indebtedness  and  the  mortgage  be  satisfied  upon 
the  record  without  the  mortgage  papers  being  sur- 
rendered. You  can,  therefore,  see  the  danger  of  an 
examiner  assuming  that  because  the  company  has  in 

[22] 


Examination  of  Insurance  Companies  23 

its  possession  a  mortgage,  it  must,  therefore,  have  an 
asset  of  value.  In  New  York  at  the  present  time  a 
mortgage  cannot  be  satisfied  unless  the  original  mort- 
gage is  deposited  with  the  proper  county  officer  at  that 
time.  This,  however,  may  raise  in  you  a  false  sense 
of  security,  since  it  is  possible  under  that  law  for  the 
mortgagor  to  make  a  partial  payment  and  the  mort- 
gagee is  not  required  to  surrender  the  original  mort- 
gage. This  is  an  important  point  to  be  borne  in  mind 
when  the  company  that  you  are  examining  is  not  the 
original  mortgagee,  but  has  taken  the  mortgage  from 
another  party  by  assignment. 

You  will  recall  that  I  divided  the  work  on  the  real 
estate  holdings  of  a  company  into  two  parts :  the  first 
to  be  undertaken  by  the  attorney  or  conveyancer,  and 
the  second  to  be  undertaken  by  the  examiner.  In  the 
same  way  the  work  on  mortgages  may  be  advan- 
tageously divided.  The  attorney  should  determine  the 
presence  of  all  the  necessary  papers,  such  as  the  mort- 
gage, the  bond  and  the  application  for  the  loan  setting 
forth  the  details  of  the  property  which  is  to  be  mort- 
gaged. These  details  should  show  the  true  rental 
value,  the  value  of  the  land,  the  value  of  the  buildings, 
if  any,  how  long  the  building  has  been  constructed, 
and  all  of  the  other  data  which  are  necessary  in  order 
that  the  board  of  directors  or  the  finance  committee 
may  pass  intelligently  upon  the  loan.  He  should  also 
find  in  each  case  some  evidence  that  the  property  has 
been  appraised  by  disinterested,  competent  people. 
The  margin  of  safety  which  must  exist  between  the 
value  of  the  property  and  the  loan  which  is  made 
thereon  varies  in  different  States.  In  some,  the  loan 
may  not  exceed  50  per  cent,  of  the  value  of  the  prop- 


24)  Examination  of  Insurance  Companies 

erty,  while  in  others  the  loan  may  be  66%  per  cent, 
of  the  value,  the  law  in  the  latter  case  requiring  that 
the  property  shall  be  worth  at  least  50  per  cent,  more 
than  the  amount  loaned  thereon. 

In  the  case  of  a  mortgage  loan,  there  should  be  an 
abstract  of  title  which  will  indicate  that  the  title  was 
in  the  mortgagor  at  the  time  that  the  loan  was  made, 
whether  any  prior  mortgage  has  been  given  and 
recorded  and  whether  there  are  any  liens  of  any  kind 
recorded  against  the  property.  The  abstract  should 
be  brought  down  to  show  that  the  mortgage  under 
consideration  has  been  recorded  by  the  proper  county 
officer.  There  should  also  be  some  evidence  of  a 
search  having  been  made  in  the  proper  office  for  evi- 
dence of  unpaid  taxes,  unpaid  water  rents  or  any 
other  liens  of  any  kind,  and  these  should  of  course  be 
cleared  up  before  the  loan  is  made. 

The  statutes  do  not  permit  insurance  companies 
to  invest  in  second  mortgages,  and  in  order  to  deter- 
mine whether  the  mortgage  in  which  the  company  has 
invested  its  funds  is  a  first  lien  on  the  property,  you 
will  of  course  realize  the  importance  of  ascertaining 
that  there  are  no  unpaid  taxes  or  liens  recorded 
against  it.  In  some  states  there  is  a  recording  tax 
which  must  be  paid  at  the  time  that  the  mortgage  is 
recorded  and  it  is  important  to  observe  that  this  has 
been  properly  attended  to,  for  under  the  New  York 
procedure,  for  instance,  it  is  impossible  to  foreclose  a 
mortgage  without  setting  forth  at  some  time  that  the 
recording  tax  has  been  properly  paid. 

Now  as  to  the  examiner's  work.  He  should  care- 
fully observe  that  all  the  details  of  the  mortgage  cor- 
respond with  the  details  set  out  in  the  schedule  of 


Examination  of  Insurance  Companies  25 

mortgages  which  the  company  is  compelled  to  file  with 
Insurance  Departments.  Upon  him  also  devolves  the 
duty  of  determining  the  security  behind  the  mortgage, 
and  for  this  purpose  it  becomes  necessary  to  employ 
an  appraiser  familiar  with  the  local  conditions  sur- 
rounding the  parcel  upon  which  the  mortgage  has  been 
placed;  you  will  recall  that  in  the  case  of  real  estate 
holdings  I  advised  the  employment  of  at  least  two 
competent  appraisers ;  in  the  case  of  mortgages  I  think 
that  one  should  be  sufficient.  There  is  a  greater  neces- 
sity for  determining  the  value  of  the  property  with 
great  exactitude  in  the  case  of  real  estate  holdings, 
for  the  company  may  properly  claim  that  any  excess 
of  the  appraised  value  of  the  property  over  the  book 
value  should  be  allowed  as  an  asset.  In  the  case  of 
mortgages,  however,  the  asset  value  remains  station- 
ary, irrespective  of  any  increase  in  the  value  of  the 
property,  and  we  are  concerned  only  with  determining 
whether  the  required  margin  of  safety  exists. 

The  statutes  of  nearly  all  the  states  prohibit  the 
loaning  of  the  funds  of  an  insurance  company  upon 
unimproved  property,  and  the  examiner  will,  therefore, 
be  compelled  to  consider  the  value  of  the  buildings  as 
well  as  that  of  the  land ;  it  becomes  necessary  for  him, 
therefore,  to  scrutinize  the  fire  insurance  policies 
which  the  mortgagee  holds  for  his  protection  in  the 
event  of  the  destruction  of  the  buildings  and  the  con- 
sequent reduction  in  his  security.  Observe  that  they 
are  in  solvent,  admitted  companies  and  that  the  poli- 
cies contain  what  is  known  as  the  ''  mortgagee  " 
clause,  which  not  only  provides  that  the  loss  or  dam- 
age, if  any,  under  the  policy  shall  be  payable  to  the 
mortgagee  instead  of  to  the  owner  of  the  property, 


26  Examination  of  Insurance  Companies 

but  that  the  interest  of  the  mortgagee  shall  not  be 
invalidated  by  numerous  acts  of  the  mortgagor  or 
owner  over  which  he  (the  mortgagee)  has  no  control 
and  which  ordinarily  would  void  the  policy. 

A  mortgage  calls  for  a  definite  rate  of  interest,  pay- 
able upon  certain  dates ;  it  is  advisable  to  note  whether 
any  discrimination  has  been  shown  by  the  company 
in  making  loans  upon  property  owned  by  its  officers 
or  their  friends  at  rates  of  interest  not  equal  to  the 
rate  received  from  other  borrowers. 

You  should  also  note  whether  the  interest  is  paid 
promptly,  as  this  is  one  of  the  best  negative  indica- 
tions of  the  value  of  the  property;  I  mean  by  this, 
that  if  the  mortgagor  does  not  pay  his  interest 
prompty,  we  naturally  look  with  some  suspicion  upon 
the  parcel  and  should  scrutinize  it  more  carefully  in 
order  that  we  may  determine  whether  in  the  event  of 
foreclosure,  the  investment  and  the  expenses  will  be 
fully  protected  by  the  value  of  the  property.  On  the 
other  hand  an  examination  of  the  history  of  the  mort- 
gage may  indicate  that  there  is  no  necessity  for  having 
it  appraised,  for  if  we  find  that  the  mortgagor  has 
reduced  his  loan  by  substantial  payments  it  is  a  very 
good  indication  that  the  remainder  is  amply  protected. 
If,  however,  the  mortgagee  in  consideration  of  this 
partial  payment  has  released  any  of  the  security  which 
stood  behind  the  original  loan,  it  becomes  necessary 
to  carefully  observe  whether  the  part  that  remains  is 
ample  to  secure  the  balance  of  the  loan. 

In  selling  a  piece  of  property  which  it  owns,  a  com- 
pany is  frequently  required  to  accept  part  of  the  pur- 
<ihase  money  in  the  shape  of  a  mortgage  on  the  prop- 
erty; these  are  called  ''  purchase  money  mortgages,'* 


Examination  of  Insurance  Companies  27 

and  it  must  be  apparent  to  you  that  an  appraisal  is 
hardly  necessary  in  these  cases. 

Another  important  point  to  which  I  wish  to  direct 
your  attention  is  the  manner  in  which  the  mortgagor 
receives  the  notification  of  the  amount  of  interest  due 
upon  the  interest  dates.  If  you  find,  for  instance,  that 
it  is  the  practice  of  the  company  to  send  out  notices 
periodically  to  its  mortgagors  notifying  them  that  a 
certain  interest  payment  is  due,  it  is  evident  that  this 
constitutes  a  notice  to  the  mortgagor  of  the  amount 
of  the  outstanding  indebtedness;  when  he  pays  the 
amount  called  for  by  the  notice,  it  is  a  tacit  admission 
upon  his  part  that  the  amount  of  the  unpaid  principal 
is  the  amount  shown  in  the  notice.  If  you  should  find, 
however,  that  the  interest  is  not  collected  direct  from 
the  mortgagor,  but  is  collected  through  the  medium  of 
some  financial  agent  or  trust  company,  it  is  advisable 
to  communicate  directly  with  the  mortgagor  for  the 
purpose  of  obtaining  from  him  an  acknowledgment  of 
the  amount  of  his  indebtedness  to  the  company.  Ap- 
pendix C  is  a  form  of  notice  which  I  have  prepared 
for  this  purpose,  and  it  aims  to  overcome  the  annoy- 
ances which  have  been  experienced  in  the  past  by  the 
companies  as  a  result  of  these  notices.  Many  mort- 
gagors were  unable  to  appreciate  the  cause  of  the 
inquiry  and  imagined  that  their  loans  were  being 
called;  the  reassuring  sentences  in  the  concluding 
paragraph  in  the  notice  are  intended  to  meet  this 
situation. 

You  may  have  occasion  to  consider  a  form  of  invest- 
ment known  as  ''  guaranteed  mortgages."  These  are 
mortgages  upon  which  some  corporation,  chartered  for 
that  purpose,  guarantees  that  the  interest  will  be  paid 


28  Examination  of  Insurance  Companies 

when  due  and  that  the  principal  will  be  paid  within 
eighteen  months  of  the  date  of  maturity,  whether  the 
mortgagor  makes  the  payments  to  it  or  not.  For  these 
services  it  is  the  practice  of  the  guaranteeing  company 
to  charge  one-half  of  1  per  cent. ;  that  is,  if  the  mort- 
gagor pays  interest  to  it  at  the  rate  of  51/2  per  cent., 
the  mortgage  is  sold  to  you  on  a  5  per  cent,  basis.  In 
these  cases  the  guaranteeing  company  retains  all  of  the 
incidental  papers,  such  as  the  fire  insurance  policies 
and  the  abstract ;  it  usally  gives  to  the  purchaser  a  title 
policy  or  incorporates  a  title  policy  in  its  guarantee; 
the  purchaser  receives  the  bond,  the  mortgage  and  an 
assignment,  the  latter  being  recorded,  if  desired.  The 
same  rule  applies  here  as  in  the  case  of  title  insurance 
policies  in  real  estate,  viz.,  if  the  guaranteeing  com- 
pany is  a  solvent,  responsible  institution,  the  guarantee 
is  an  excellent  thing.  The  examiner,  however,  should 
consider  the  guarantee  merely  in  the  nature  of  an  addi- 
tional safeguard  and  should  apply  to  that  parcel  the 
same  tests  which  he  would  apply  if  no  guarantee 
existed. 

Another  form  of  investment  with  which  you  may 
possibly  be  brought  in  contact  (whether  it  is  a  form 
of  investment  which  may  be  made  by  insurance  com- 
panies is  not  entirely  clear  in  my  mind  and  I  do  not 
know  whether  the  question  has  ever  been  passed 
upon)  is  what  is  known  as  a  "  transfer  of  tax  lien." 
If  the  owner  of  a  piece  of  property  in  New  York  does 
not  pay  his  taxes  to  the  city,  the  taxing  authorities 
after  a  certain  number  of  years  has  elapsed,  sell  to 
the  highest  bidder  the  right  to  collect  this  tax  with 
interest  from  the   time  of  sale.     The  purchaser  of 


Examination  of  Insurance  Companies  29 

these  tax  liens  must  pay  these  back  taxes,  of  course, 
to  the  citj^  The  basis  upon  which  the  city  sells  it,  is 
that  the  purchaser  who  is  willing  to  take  it  at  the 
lowest  rate  of  interest  is  awarded  the  lien.  In  other 
words,  if  two  bidders  want  a  lien,  one  being  willing  to 
accept  5  per  cent,  and  the  other  5l^  per  cent.,  the  city 
would  sell  it  to  the  one  willing  to  take  it  at  5  per  cent. 
In  this  case  the  owner  of  the  property  would  have  to 
pay  to  the  purchaser  the  amount  he  paid,  together 
with  interest  at  5  per  cent,  for  the  period  between  the 
date  of  the  tax  sale  and  the  date  of  the  redemption, 
with  an  added  penalty  in  the  shape  of  interest  for  six 
months.  These  tax  liens  are  prior  to  any  first  mort- 
gage or  any  other  lien  which  may  exist  against  the 
property,  except  of  course  city  taxes  which  may  be 
assessed  after  the  date  of  the  lien.  The  usual  period 
which  these  liens  must  run  before  foreclosure  can  be 
made,  is  three  years,  although  at  the  option  of  the 
purchaser  foreclosure  may  be  started  after  thirty  days 
from  the  failure  of  the  owner  to  pay  the  semi-annual 
interest  on  the  tax  lien,  or  six  months  after  any  failure 
upon  the  owner's  part  to  pay  subsequent  taxes. 


CHAPTER  IV 

Bonds  —  Different  Forms  of  Bonded  Indebtedness  — 
Railroad  Bonds  —  Registered  and  Coupon  Bonds  — 
Directors  not  to  be  Interested  in  Sales  or  Purchases 
—  Evidence  of  Ownership. 

A  bond  may  be  briefly  and  generally  described  as  a 
promise  to  pay  a  definite  sum,  at  a  definite  time,  with 
a  definite  rate  of  interest.  You  understand,  of  course, 
that  this  is  not  an  inflexible  definition,  for  in  some 
cases  it  is  subject  to  modification.  The  bonds  issued 
by  the  British  Grovernment,  for  example,  known  as 
"  British  Consuls  "  are  perpetual,  having  no  definite 
date  of  maturity.  At  least  one  of  the  railroad  com- 
panies in  this  country  has  issued  bonds  which  are  per- 
petual, and  the  United  States  Grovernment  in  one  of 
its  2  per  cent,  issues  has  provided  that  the  principal 
may  be  paid  at  the  pleasure  of  the  government  at  any 
time  after  1930.  There  are  other  bonds  which  are, 
strictly  speaking,  not  perpetual,  but  run  for  very  long 
terms :  one  of  the  issues  of  the  West  Shore  Railroad, 
the  nominal  maturity  date  of  which  is  2004,  is  an 
instance  of  this  kind. 

I  shall  briefly  review  this  morning  the  different 
kinds  of  bonds  with  which  you  may  be  brought  in  con- 
tact in  your  examination  of  companies. 

Government  Bonds 

Bonds  of  the  United  States  Government  are  now 
held  generally  for  sentimental  purposes,  their  value 

[30] 


Examination  of  Insueance  Companies  31 

from  an  investment  standpoint  having  disappeared; 
the  bonds  of  other  governments  usually  found  among 
companies  which  transact  business  in  this  country  are 
those  of  the  United  States  of  Mexico,  the  Provinces 
of  Canada  and  the  Imperial  Japanese  Government; 
companies  transacting  business  in  foreign  countries 
are  likely  to  have  bonds  of  the  countries  in  which  they 
do  business  and  you  will  therefore  probably  find  in 
the  course  of  your  work  the  bonds  of  Germany, 
France  and  Russia,  these  being  the  most  usual 
instances. 

State  Bonds 

The  bonds  of  the  various  states  in  this  country  have 
usually  been  issued  at  very  low  rates  of  interest,  the 
credit  of  the  states  being  very  high;  in  fact  some  of 
the  states  have  no  outstanding  indebtedness  of  any 
kind. 

m 

Municipal  Bonds 

In  this  group  are  included  the  bonds  of  counties, 
cities,  villages,  townships,  school  districts,  drainage 
districts  and  other  political  subdivisions;  here  the 
value  largely  depends  upon  the  relation  which  the 
taxable  value  of  the  property  in  the  political  unit 
bears  to  the  amount  of  outstanding  indebtedness.  As 
a  usual  thing,  municipal  bonds  constitute  an  unim- 
peachable form  of  investment,  and  are  sold  and  quoted 
on  what  is  known  as  a  rate  basis.  If,  for  instance,  the 
bonds  of  a  certain  village  are  said  to  sell  upon  a  3.80 
per  cent,  basis,  it  is  understood  that  after  taking  the 
date  of  maturity  and  the  rate  of  interest  stated  in  the 
bond,  into  account,  the  purchaser  will  net  3.80  per 
cent,  upon  his  investment. 


S'2  Examination  of  Insurance  Companies 

Irrigation  Bonds 

These  are  the  bonds  which  have  been  issued  against 
irrigation  rights  and  of  late  have  come  into  favor 
owing  to  the  high  rate  of  interest  which  they  bear. 
Many  of  the  lands  in  the  western  States  are  being 
reclaimed  by  means  of  irrigation  projects,  which  are 
either  operated  by  private  capital  or  by  governmental 
assistance  and  the  value  of  the  irrigation  bonds  de- 
pends very  largely  upon  this  factor. 

Public  Service  Bonds 

These  are  securities  issued  by  street  railways,  gas 
companies,  electric  light  companies,  water  companies 
and  other  corporations  which  deal  exclusively  in  those 
things  which  are  used  for  public  service  purposes. 
Their  value  is  largely  dependent  upon  the  franchises 
which  these  companies  enjoy,  the  bonded  indebtedness 
and  the  density  of  the  population  of  the  localities 
which  they  serve. 

Industrial  Bonds 

Some  corporations  dealing  in  public  utilities,  but 
which  do  not  transact  a  public  service  business,  have 
outstanding  bond  issues  with  which  the  examiner  is 
frequently  brought  in  contact.  Such  are  the  bonds, 
for  example,  of  the  Central  Leather  Company  and  the 
United  States  Steel  Corporation. 

Railroad  Bonds 

This  class  of  securities  probably  constitutes  the 
largest  item  in  the  bond  holdings  of  insurance  com- 
panies and  it  is  my  intention  to  briefly  refer  to  some 
of  the  different  forms  of  railroad  bonds  in  order  that 


Examination  of  Insurance  Companies  33 

you  may  become  familiar  with  the  terms  employed. 
My  designations  are  not  intended  to  provide  a  defini- 
tion of  the  relationship  of  the  various  parties  to  the 
contract  from  a  legal  standpoint.  This  could  only  be 
furnished  after  an  exhaustive  investigation  into  the 
various  agreements  and  contracts  into  which  the  rail- 
road companies  have  entered  for  the  protection  of 
each  individual  issue. 

Some  of  the  most  common  issues  of  railroad  bonds 
are: 

First  mortgage.  Debenture. 

Second  mortgage.  Convertibles. 

Consolidated.  Equipment  or  car  trust. 

Unified.  Eefunding. 

General  mortgage.  Adjustment. 

Income.  Sinking  fund. 

Collateral  trust.  Prior  lien.  ■■ 

The  mere  title  of  a  bond  is  not  a  safe  index  to  either 
its  value  or  its  terms. 

Eailroad  bonds  may  be  broadly  divided  into  two 
classes  —  first  mortgage  and  all  other.  But  even  the 
designation  of  a  bond  as  a  ''  first  mortgage  bond  " 
may  create  a  false  impression.  The  first  mortgage 
bonds  of  a  holding  company  do  not  necessarily  carry 
with  them  a  first  mortgage  lien  on  the  railroads,  the 
stock  of  which  is  held  by  the  holding  company.  A 
true  first  mortgage  bond  is  a  mortgage  upon  a  definite 
mileage,  and  constitutes  its  first  bonded  lien. 

In  former  years  a  conservative  railroad  did  not 
mortgage  its  system  for  more  than  $20,000  a  mile. 
At  the  present  time  it  is  no  unusual  thing  to  find  roads 
mortgaged  up  to  $40,000  a  mile,  the  necessity  for  a 

3 


34  Examination  of  Insurance  Companies 

more  substantial  roadbed  and  heavier  rails  being  fac- 
tors which  have  contributed  to  this  condition.  After 
the  first  mortgage  bonds  were  issued,  and  before  their 
maturity,  the  railroads  found  that  it  became  necessary 
to  secure  more  money  and  other  bonds  were  issued. 
The  name  "  second  mortgage,"  for  various  reasons, 
was  not  popular  with  the  investing  public,  and  the 
railroad  companies  gave  their  issues  other  names. 
Consolidated,  unified,  general  mortgage  bonds  are  all 
second  liens  until  the  underlying  mortgage  bonds  have 
matured  or  are  paid  off.  As  soon  as  the  first  mort- 
gage bonds  are  out  of  the  way  the  subsequent  issues 
become  first  liens  upon  the  property. 

A  debenture  bond,  in  this  country,  has  come  to  mean 
a  bond  secured  almost  exclusively  by  the  credit  of  the 
road  which  issues  it,  without  having  any  definite  prop- 
erty behind  it.  While  it  is  a  definite  promise  to  pay, 
and  in  that  way  differs  from  the  capital  stock,  it  is 
more  in  the  nature  of  a  note.  There  is  another  impor- 
tant point  of  difference  between  a  debenture  bond  and 
the  capital  stock  in  that  if  the  interest  on  the  former 
be  not  promptly  paid,  the  holders  can  obtain  a  judg- 
ment which,  if  not  satisfied,  can  form  the  basis  of  a 
foreclosure  suit. 

Income,  convertible  and  in  many  cases  collateral 
trust  bonds  are  issues  which  are  more  in  the  nature 
of  debenture  bonds  than  of  the  others.  An  income 
bond  may  be  broadly  described  as  a  promise  to  pay 
the  principal,  with  interest  at  a  definite  rate,  from  the 
income  earnings  of  the  system.  Convertible  bonds 
provide  that  within  a  certain  number  of  years  the 
holder  of  them  may  exchange  them  for  the  common 
stock  of  the  railroad.    Collateral  trust  bonds  are  bonds 


Examination  oe  Insurance  Companies  35 

whicli  have  been  issued  against  the  deposit  of  a  certain 
amount  of  bonds  of  the  road  or  some  of  its  systems 
and  which  have  been  placed  in  a  fund  for  the  protec- 
tion of  this  bond  issue. 

Equipment  or  car  trust  bonds  are  usually  issued  for 
short  terms  for  the  purpose  of  paying  for  additional 
rolling  stock,  and  it  is  the  usual  practice  for  the  rail- 
road issuing  these  equipment  bonds  to  place  the  title 
to  the  rolling  stock  in  the  name  of  some  trustee,  usu- 
ally a  trust  company,  which  receives  from  the  railroad 
company  a  certain  amount  from  the  current  receipts 
for  the  purpose  of  redeeming  these  equipment  bonds 
at  their  maturity  and  paying  the  interest  upon  them 
in  the  meanwhile. 

Refunding  and  adjustment  bonds  are,  as  their  names 
indicate,  intended  for  the  purpose  of  redeeming  issues 
which  are  about  to  mature.  Sinking  fund  bonds  as  a 
usual  thing  are  securities,  the  maturity  of  which  is 
provided  for  by  the  accumulation  of  a  sinking  fund. 

It  is  necessary  for  the  examiner  in  scrutinizing  the 
bond  holdings  of  a  company  to  observe  the  rate  of 
interest,  the  date  of  maturity,  and  the  general  classifi- 
cation of  the  bond,  for  upon  these  factors  will  depend 
the  market  values.  It  is  necessary  to  note  whether 
the  bonds  contain  an  option  of  redemption,  for  if  the 
issuing  company  retain  the  right  to  redeem  a  50-year 
bond  at  its  pleasure  after  ten  years  have  expired,  it 
is  quite  evident  that  this  must  not  be  considered  as  a 
50-year  bond.  The  effect  which  such  a  provision  will 
have  upon  the  market  value  is  very  peculiar.  If  a 
bond  has  been  purchased  at  a  premium,  the  redemp- 
tion option  must  be  taken  into  account  in  determining 
the  true  value  of  the  investment,  but  if  the  security 


36  Examination  of  Insurance  Companies 

has  been  purchased  below  par  this  option  of  redemp- 
tion must  be  disregarded.  This  phase  of  the  question 
will  be  referred  to  more  at  length  in  my  talk  on  amor- 
tization. 

Bonds  are  issued  in  two  forms:  registered  bonds 
and  coupon  bonds.  Registered  bonds  are  those  which 
are  not  payable  to  the  bearer,  but  which  provide  that 
the  principal  or  the  interest  or  both  shall  be  paid  to 
some  corporation,  firm  or  individual,  the  name  of 
which  appears  upon  the  bond  and  is  registered  in  the 
books  of  the  company.  In  the  case  of  those  bonds 
which  are  registered,  as  to  interest,  the  investor  re- 
ceives his  interest  payments  in  the  form  of  cheques 
sent  from  the  head  office  of  the  corporation  issuing 
them,  and  these  bonds,  therefore,  contain  no  sheets  of 
coupons. 

Coupon  bonds  are  payable  to  the  bearer  or  holder, 
and  the  interest  is  payable  in  the  shape  of  coupons 
which  are  detached  upon  their  due  dates  and  deposited 
in  some  banking  institution.  A  bond  may  be  regis- 
tered as  to  its  principal,  but  its  interest  payments  may 
be  provided  for  by  sheets  of  coupons.  In  the  case  of 
coupon  bonds  it  is  necessary  in  examining  a  com- 
pany to  observe  whether  the  unmatured  coupons  are 
attached  to  the  bond  and  if  not  some  adequate  expla- 
nation should  be  offered  for  their  absence. 

In  outlining  the  development  of  departmental  exam- 
inations, I  indicated  that  methods  had  changed  mate- 
rially in  the  past  years.  Within  the  past  three  years 
some  of  the  States  have  enacted  statutes  which  pro- 
hibit the  directors  and  officers  of  insurance  companies 
from  being  financially  interested  in  the  sale  or  pur- 
chase of  the  company's  securities.     Section  36  of  the 


Examination  of  Insurance  Companies  37 

New  York  Insurance  Law  is  an  instance  of  this.     (See 
Appendix  D.) 

In  order  that  you  may  be  sure  that  the  securities 
have  not  been  borrowed  for  the  purpose  of  exhibiting 
them  to  the  examiner  or  for  temporary  purposes,  it 
is  well  to  satisfy  yourself  that  the  company's  title  to 
the  securities  is  the  result  of  an  actual  purchase.  This 
evidence  will  be  exhibited  to  you  either  in  the  shape  of 
the  receipted  bills  from  the  vendor  or,  if  you  desire 
more  affirmative  information,  you  can  obtain  it  from 
an  inspection  of  the  entries  in  the  cash  book,  supple- 
mented by  an  inspection  of  the  cheques  or  vouchers 
themselves. 


CHAPTER  V 

Difference  Between  Bonds  and  Stocks  —  Danger  in 
Stock  Investments  —  Preferred,  Common  and  Guar- 
anteed Stocks  —  Collateral  Loans  —  *  *  Window 
Dressing  ' '  —  Collateral  Loans  Contrasted  with 
Policy  Loans. 

In  my  talk  to  you  the  other  day  I  pointed  out  that, 
although  there  might  be  some  differences  in  the  extent 
of  security  behind  it,  a  bond  was  a  definite  promise  to 
pay;  to-day  I  wish  to  refer  to  this  in  order  that  you 
may  realize  the  difference  between  a  bond  and  a  cer- 
tificate of  stock.  A  certificate  of  stock  is  merely  an 
evidence  of  the  holder's  equity  in  a  corporation:  it 
indicates  that  he  is  a  partner  in  the  business:  there 
is  no  promise  to  pay  any  smu  at  any  time  and  until 
the  company  is  liquidated  or  the  stock  retired,  there 
is  no  chance  for  an  investor  to  receive  the  principal  of 
his  investment. 

An  insurance  company  is  a  semi-public  corporation 
and  you  can  readily  appreciate  the  danger  to  it  of  an 
investment  in  the  capital  stock  of  another  corporation. 
If  the  funds  of  the  policyholders  are  to  be  used  for 
the  purpose  of  purchasing  a  partnership  in  a  different 
kind  of  business,  the  policyholder  should  be  prepared 
to  experience  the  penalties  of  a  losing  venture  in  the 
same  way  that  he  will  benefit  by  a  profitable  one.  I 
have  in  mind  the  case  of  a  life  insurance  company 
which  purchased  a  number  of  shares  in  a  casualty 

[38] 


Examination  op  Insurance  Companies  39 

company.  The  latter 's  business  was  not  conducted 
along  proper  lines,  and  in  consequence  the  stock- 
holders had  to  meet  an  assessment  on  their  stock  in 
order  that  the  casualty  company  might  remain  solvent 
and  be  permitted  to  transact  business  in  the  various 
States.  As  the  life  insurance  company  was  a  stock- 
holder, it,  with  all  the  others,  had  to  contribute  to  this 
additional  payment.  As  a  result  the  life  insurance 
policyholders  have  invested  many  times  the  amount  of 
their  original  purchase  in  the  capital  stock  of  the 
casualty  company,  and  it  is  almost  unnecessary  for  me 
to  point  out  that  this  is  an  entirely  improper  channel 
of  investment  for  the  funds  of  the  policyholders. 

You  will  appreciate  this  danger  by  stopping  to  con- 
sider the  manner  in  which  the  stockholders  of  national 
banks  are  regarded.  If  for  any  reason  the  funds  of  a 
national  bank  become  seriously  impaired,  not  only  do 
the  stockholders  lose  all  of  their  investment  in  the 
capital  stock,  but  under  the  National  Banking  Law 
they  are  liable  for  an  assessment  equal  to  the  par 
value  of  their  stock  holdings.  If  an  insurance  com- 
pany, for  instance,  had  $100,000  of  the  capital  stock 
of  a  national  bank  and  through  poor  investments  or 
defalcations  the  affairs  of  the  bank  became  involved, 
the  insurance  company  would  have  to  protect  the 
depositors  not  only  to  the  extent  of  its  original  invest- 
ment of  $100,000,  but  also  to  the  extent  of  an  addi- 
tional $100,000  if  it  were  needed. 

It  is  pertinent  that  at  this  time  I  should  call  your 
attention  to  the  fact  that  from  our  viewpoint  there  is 
a  difference  between  a  life  insurance  company  and  a 
company  transacting  other  forms  of  insurance. 

The  policy  contracts  of  a  life  insurance  company 


40         Examination  of  Insurance  Companies 

may  run  for  a  long  term  of  years,  and  it  is  no  imusual 
thing  for  policies  to  be  in  force  forty,  fifty  or  sixty 
years  from  their  dates  of  issue.  The  continued  suc- 
cess, therefore,  of  a  life  insurance  company  depends 
upon  the  safe  investment  of  its  funds  in  such  a  way 
that  they  will  earn  the  rate  of  interest  assumed  in  the 
calculation  of  the  premiums. 

The  contracts  of  other  insurance  companies  run  for 
shorter  terms  as  compared  with  the  policies  of  a  life 
insurance  company,  and  the  premium  rates  are  not 
predicated  upon  the  investments  earning  a  definite 
rate  of  interest.  I  mention  this  fact  in  order  that  you 
may  see  the  direct  bearing  it  has  on  the  point  to  which 
I  am  now  going  to  refer,  viz.,  that  if  the  corporation, 
the  stock  of  which  the  insurance  company  holds,  is  not 
successful,  no  dividends  are  payable  upon  the  stock 
and  therefore  the  earning  power  of  the  investment  is 
crippled ;  while  this  might  be  a  very  serious  matter  to 
a  life  insurance  company,  you  will  see  that  it  will  not 
have  the  same  effect  upon  companies  transacting  other 
forms  of  business. 

In  the  State  of  New  York  at  the  present  time,  life 
insurance  companies  are  not  permitted  to  invest  in  or 
loan  upon  the  stock  of  any  corporation  (see  Appendix 
E) ;  the  exception  noted  in  the  statute  relates  to  the 
stocks  of  a  municipal  corporation,  which  are  more  in 
the  nature  of  bonds,  and  the  criticisms  noted  above 
cannot  properly  be  applied  to  them. 

The  two  forms  of  stock  which  will  probably  come 
to  your  attention  in  the  examination  of  insurance  com- 
panies, are  preferred  and  common,  either  of  which 
may  be  guaranteed. 

The  preferred  stockholders  of  a  corporation  are 


Examination  of  Insurance  Companies  41 

entitled  to  a  distribution  of  the  earnings  of  the  corpo- 
ration before  any  dividends  are  declared  upon  the 
common  stock,  and  in  some  cases  are  entitled  to  prior- 
ity in  the  event  of  liquidation.  After  the  interest  on 
the  bonded  indebtedness  and  the  other  fixed  charges 
have  been  met,  the  preferred  stockholders  are  entitled 
to  a  dividend  if  in  the  judgment  of  the  directors  such 
a  payment  be  advisable.  A  preferred  stockholder's 
certificate  does  not  entitle  him  to  a  definite  payment, 
but  merely  to  an  equity  in  the  earnings.  As  a  usual 
thing,  on  preferred  stocks  the  dividend  is  limited  to 
a  certain  amount,  althougib.  the  preferred  stockholders 
in  some  corporations  are  entitled  to  an  additional 
dividend  after  the  common  stockholders  have  received 
their  dividend. 

The  common  stock  of  a  corporation  entitles  its 
holder  to  the  profits  which  are  apportioned  by  the 
directors;  it  is  quite  evident  that  before  the  common 
stockholders  can  receive  any  dividends,  the  interest 
on  the  bonds,  the  fixed  charges  and  the  dividends  to 
the  preferred  stockholders  (if  any  preferred  stock  has 
been  issued)  must  be  paid. 

When  a  railroad  corporation  leases  its  lines  to  an- 
other corporation,  one  of  the  terms  of  the  lease  may 
provide  that  the  lessee  shall  pay  dividends  at  a  certain 
rate  upon  the  outstanding  capital  stock  of  the  lessor. 
These  shares  thereby  become  "  guaranteed  stocks," 
but  it  must  be  evident  to  you  that  their  security 
depends  upon  the  earning  power  of  the  road  which  has 
assumed  the  operation  of  the  leased  lines. 

In  examining  an  insurance  company  which  holds 
certificates  of  stock  among  its  assets,  it  is  necessary 
to  observe  whether  the  certificates  stand  in  the  name 


42         Examination  of  Insukanoe  Companies 

of  the  company  or  in  the  name  of  some  individual 
who  has  assigned  them  to  the  company  in  blank.  The 
latter  is  a  very  dangerous  condition,  for  it  permits  the 
certificates  to  be  used  by  any  person  into  whose  hands 
they  may  fall.  It  is  important,  therefore,  that  stock 
certificates  should  be  issued  to  the  corporation,  or,  if 
indorsed,  the  name  of  the  insurance  company  should 
be  specifically  set  forth  in  the  indorsement.  There  are 
cases  where  the  entire  stock  issue  of  a  corporation 
may  be  owned  by  an  insurance  company,  in  which  case 
it  is  necessary  that  certain  individuals  should  hold 
qualifying  shares  to  enable  /ilaem  to  act  as  directors, 
but  in  this  case  the  rule  for  the  indorsement  just  cited 
should  be  followed. 

In  connection  with  the  question  of  certificates  of 
stock,  you  should  know  that  section  16  of  the  New 
York  Insurance  Law  permits  surety  companies  to 
invest  in  and  loan  on  the  stock  of  a  similar  corpora- 
tion transacting  business  in  other  countries  (see  Ap- 
pendix F). 

You  will,  of  course,  observe  whether  the  bonds  and 
stock  certificates  of  an  insurance  company  are  kept  in 
a  secure  place.  Unless  a  company  is  of  a  sufficiently 
large  size  to  justify  it  in  having  a  specially  con- 
structed vault  on  its  own  premises,  it  is  usual  for 
companies  to  keep  their  securities  in  public  safe 
deposit  vaults ;  caution  requires  that  access  should  not 
be  had  to  such  vaults  by  less  than  two  of  the  officers  or 
employees  of  the  insurance  company,  appearing  at  the 
same  time. 

In  some  cases  you  will  find  that  among  the  assets 
of  an  insurance  company  are  loans  on  collateral ;  these 
are  loans  which  have  been  made  to  an  individual  or 


Examination  of  Insurance  Companies  43 

a  firm  or  a  corporation  upon  their  note  secured  by  the 
deposit  of  certain  collateral.  This  collateral  may  con- 
sist of  bonds  or  stock  certificates  or  even  the  assign- 
ment of  a  mortgage,  which  assignment  has  not  been 
recorded. 

In  my  opinion  collateral  loans  are  a  form  of  invest- 
ment which  belong  more  properly  to  banking  institu- 
tions than  to  insurance  companies.  I  think  that  an 
insurance  company  should  not  be  burdened  with  the 
necessity  of  looking  after  the  securities  which  have 
been  pledged  as  a  security  for  a  loan.  They  may  be 
of  such  a  nature  as  to  have  a  constantly  fluctuating 
market  value,  in  which  case  the  company  must  keep  in 
constant  touch  with  the  stock  market.  It  goes  without 
saying  that  in  no  case  should  a  loan  be  made  upon  any 
kind  of  collateral  in  which  the  insurance  company 
would  not  invest  its  own  funds,  for,  should  the  bor- 
rower fail  to  pay  his  note  upon  its  due  date,  the  com- 
pany would  have  to  take  the  collateral  in  satisfaction 
of  its  debt  if  it  could  not  secure  the  repayment  of  its 
loan  from  the  borrower.  In  consequence,  any  loans 
which  are  made  upon  securities  in  which  the  company 
is  not  authorized  to  invest  its  own  funds  should  be 
disallowed  in  the  calculation  of  its  assets. 

The  examiner  should  pay  particular  attention  to  the 
collateral  loan,  should  determine  whether  the  interest 
is  paid  promptly,  and  should  also  observe  whether  the 
note  is  past  due.  In  the  latter  case  some  adequate 
explanation  should  be  offered  to  account  for  the 
condition. 

It  is  also  essential  that  the  name  of  the  actual  bor- 
rower in  each  case  should  be  known.  The  use  of 
**  dummy  borrowers  "  should  be  condemned,  and  their 


44         Examination  of  Insurance  Companies 

employment  will  undoubtedly  be  found  to  lead  to  con- 
ditions which  should  be  discouraged.  The  funds  of  an 
insurance  company  should  never  be  used  for  the  pur- 
pose of  personal  aggrandizement  or  for  the  conveni- 
ence of  the  officers  and  their  friends.  The  name  of  the 
actual  borrower  in  many  cases  indicates  whether  the 
funds  are  being  used  for  such  purposes. 

I  wish  to  briefly  refer  to  a  term  with  which  you 
may  be  familiar  in  connection  with  collateral  loans. 
"  Window  dressing  "  has  been  applied  to  that  prac- 
tice in  the  past  of  some  companies  which  have  at- 
tempted to  keep  from  the  public  and  the  supervising 
officials  the  evidence  of  the  use  of  their  funds  for  col- 
lateral loan  purposes;  as  the  companies  are  required 
to  prepare  their  statements  as  of  December  31st,  any 
loans  which  were  made  on  or  after  January  1st,  and 
repaid  before  the  close  of  business  December  31st,  did 
not  appear  in  the  schedule  of  assets.  Realizing  this,  it 
was  the  practice  of  some  companies  to  have  those  col- 
lateral loans  which  they  wished  to  hide,  paid  on  Decem- 
ber 31st,  and  two  or  three  days  afterward  remake  the 
same  loan.  A  continuance  of  this  practice  accom- 
plished the  purpose  of  keeping  the  knowledge  of  the 
loan  from  those  who  were  entitled  to  the  information 
and  led  to  a  reprehensible  condition.  The  examiner 
should  observe  the  collateral  loan  account  in  the 
ledger  for  the  purpose  of  determining  the  existence 
of  such  a  practice;  if  found,  it  should  be  condemned 
unscathingly.  The  annual  statement  blank  now  in  use 
aims  to  disclose  this  situation,  if  it  exists. 

I  wish  to  contrast  a  collateral  loan  with  a  policy 
loan ;  the  latter,  in  my  opinion,  constitutes  as  good  an 
investment  for  an  insurance  company  as  can  be  found, 


Examination  of  Insurance  Companies  45 

if  the  loan  does  not  exceed  the  reserve  which  the  com- 
pany is  required  to  maintain.  Not  only  is  the  invest- 
ment protected  by  the  securities  and  operations  over 
which  the  company  has  direct  supervision,  but  it 
carries  out  the  true  intent  and  purposes  of  a  legal 
reserve,  which,  you  will  recall,  is  nothing  more  or  less 
than  the  payment  which  the  policyholder  has  made  to 
the  company  in  excess  of  the  cost  of  furnishing  his 
insurance  in  order  that  his  premiums  may  be  kept 
level  throughout  the  history  of  the  policy.  By  loaning 
to  its  policyholder,  the  company  is  fulfilling  the 
highest  purposes  of  an  insurance  company,  inasmuch 
as  it  is  permitting  him  the  use  of  his  own  money  and 
not  permitting  the  interest  of  the  other  policyholders 
to  suffer  thereby;  he  is  paying  an  adequate  rate  of 
interest;  and  if  he  should  not  pay  his  loan  when  it 
matures,  or  the  interest,  his  policy  would  be  canceled, 
and  the  liability  of  the  company  would  cease  on  that 
score.  The  care  which  should  be  exercised  in  making 
policy  loans  will  be  referred  to  in  another  talk. 


CHAPTER  VI 

Cash  in  Office  and  in  Bank  —  Percentage  of  Cash  to 
Invested  Assets  —  Certificate  from  Banking  Institu- 
tions—  Interest  Bearing  and  Non-interest  Bearing 
Accounts  —  Policy  Loans  —  Liens  and  Their  Sources 
—  Premium  Notes. 

It  is  safe  to  say  you  will  find  in  every  company 
which  you  are  called  upon  to  examine,  cash  in  office 
or  cash  in  bank.  A  verification  of  the  cash  in  ofiice 
is,  of  course,  a  simple  matter,  and  it  will  be  sufficient 
to  merely  point  out  the  necessity  of  determining  that 
everything  in  the  cash  drawer  is  cash  or  its  equiv- 
alent. You  should  not  find  any  notes  of  officers  or  of 
employees  or  cheques  which  are  post-dated  or  cheques 
which  have  been  held  for  a  long  time  without  being 
cashed  or  cheques  which  have  been  returned  protested. 
Should  you  find  any  of  these  items,  you  will  request 
an  explanation.  Of  course,  in  some  cases  you  may 
find  that  the  cashier  has  made  temporary  advances  to 
clerks  until  the  arrival  of  the  next  salary  day,  but 
these  are  matters  which  I  feel  can  safely  be  left  to  your 
discretion. 

The  bank  deposits  may  be  divided  into  two  parts: 
first,  those  which  are  interest  bearing,  and  second, 
those  upon  which  the  bank  allows  no  interest.  In 
well-managed  companies  the  percentage  which  the 
cash  in  bank  bears  to  the  invested  assets  varies  with 
the  size  of  the  company,  special  conditions  and  the 
form  of  insurance  transacted ;  the  smaller  the  company 

[46] 


Examination  of  Instjkance  Companies         47 

the  larger  will  be  the  proportion  of  its  assets  in  this 
form.  Among  fire  insurance  companies,  for  instance, 
it  is  not  unusual  to  find  10  per  cent,  of  their  admitted 
assets  in  the  form  of  cash,  while  normally  a  life  insur- 
ance company,  operating  only  an  ordinary  department, 
would  not  have  that  amount,  and  if  we  should  find 
more  than  5  per  cent,  in  such  a  company,  we  would  be 
justified  in  carefully  examining  the  cause. 

From  an  investment  standpoint  a  large  bank  ac- 
count is  to  be  discouraged,  for  no  bank  can  aiford  to 
pay  as  high  a  rate  of  interest  as  the  company  could 
realize  from  well-selected  investments.  Non-interest 
bearing  accounts  should  not  be  found,  except  for  cur- 
rent chequing  purposes.  The  only  exception  which 
occurs  to  me  is  that  which  I  have  found  in  the  exam- 
ination of  some  of  the  smaller  life  insurance  companies 
which  have  left  their  deposits  without  interest  in 
those  banks  which  have  discounted  the  insured's  notes 
for  the  agent,  the  understanding  being  that  while  the 
company  should  in  no  way  be  held  responsible  for  the 
note,  it  would  leave  the  proceeds  with  the  discounting 
bank  until  the  note  matured. 

For  the  purpose  of  ascertaining  the  amount  of  cash 
in  the  various  banking  institutions  I  have  prepared 
a  form  of  certificate  (see  Appendix  G),  which  has  for 
its  purpose  not  only  the  securing  of  a  statement  from 
the  officers  of  the  banking  institution  relative  to  the 
amount  of  cash  which  the  company  has  on  deposit 
and  subject  to  its  cheque,  but  is  also  intended  to 
develop  whether  the  deposit  exists  for  the  purpose  of 
securing  a  loan  which  the  banking  institution  has 
made  to  any  officer,  director  or  employee  of  the  com- 
pany under  examination.     In  addition,  this  certificate 


48  EXAMINATIOI^   OF   INSURANCE   COMPANIES 

will  show  whether  the  deposit  is  the  result  of  the  com- 
pany having  discounted  notes  or  borrowed  any  money 
from  the  institution.  You  will,  of  course,  appreciate 
the  fact  that  if  a  company  has  discounted  notes  with 
a  banking  institution  in  such  a  way  that  the  bank  can 
have  recourse  to  the  company  in  the  event  of  the  non- 
payment by  the  makers  of  the  notes,  a  liability  has 
been  created  for  which  suitable  provision  should  be 
made. 

I  wish  to  refer  again  to  some  of  the  improper  con- 
ditions which  may  result  from  a  company  keeping  too 
large  a  percentage  of  its  assets  in  the  form  of  cash  in 
bank ;  it  may  indicate  that  the  officers  of  the  insurance 
company  are  interested  financially  in  the  bank  or  the 
insurance  company  is  under  some  obligation  to  the 
bank  and  is  liquidating  its  indebtedness  by  carrying  a 
large  deposit  there  at  a  low  rate  of  interest.  In  the 
case  of  newly-established  companies  (of  which  at  the 
present  time  there  are  a  great  number  in  this  country) 
you  will  probably  find  that  the  keeping  of  a  large 
amount  of  cash  in  bank  is  intimately  connected  in 
some  way  with  the  underwriting  of  the  capital  stock 
of  the  company,  and  a  clear  and  full  explanation  of  all 
the  circumstances  surrounding  this  condition  should 
be  placed  at  your  disposal. 

Yesterday  I  referred  briefly  to  the  advantages  of 
policy  loans  from  the  standpoint  of  remunerative  and 
safe  investments  for  a  life  insurance  company.  I  did 
not  touch  upon  the  methods  which  you  should  employ 
in  verifying  the  schedule  of  policy  loans  which  will  be 
furnished  to  you.  It  goes  without  saying  that  every 
such  loan  should  be  upon  the  security  of  a  policy 
which  is  in  force  and  the  reserve  for  which  is  being 


Examination  of  Insurance  Companies  49 

maintained  by  the  company;  the  policy  contract  should 
be  deposited  with  the  company  and  you  should  also 
find  a  note  evidencing  the  indebtedness  and  an  assign- 
ment to  the  company  as  security  for  the  debt,  although 
in  some  cases  the  note  and  the  assignment  are  in  one 
instrument. 

The  instrument  just  referred  to  should  be  signed  by 
the  insured  and  the  beneficiary,  although  of  recent 
years  some  insurance  policies  have  contained  a  clause 
giving  the  insured  the  right,  with  the  company's  con- 
sent, to  change  the  beneficiary  if  the  policy  has  not 
been  assigned.  In  those  cases  it  has  been  held  to  be 
unnecessary  for  the  beneficiary  to  join  the  insured  in 
the  assignment  for  the  purpose  of  securing  a  policy 
loan.  I  do  not  recall  that  this  is  the  result  of  any 
judicial  decision  (to  my  knowledge  the  point  has  not 
been  adjudicated)  or  whether  it  is  the  result  of  com- 
pany practice.  At  all  events  it  is  a  condition  which 
we  find  at  the  present  time  and  it  has  been  very  gen- 
erally accepted. 

A  policy  loan  is  a  good  investment  only  when  it  and 
the  accrued  interest  upon  it  are  equal  to,  or  less  than 
the  reserve  which  the  company  is  maintaining  upon 
the  policy;  in  a  great  many  cases  you  will  find  that 
the  policy  becomes  automatically  cancelled  when  the 
outstanding  indebtedness  against  it  exceeds  the  maxi- 
mum loan  value  to  which  it  is  entitled.  This  provision 
is  intended  to  guard  against  the  dangerous  condition 
which  would  result  from  a  policy  loan  being  in  excess 
of  the  reserve  liability  which  is  being  maintained 
upon  it,  for  this  latter  quantity  is  the  only  thing  which 
protects  the  company  against  loss  in  the  event  of  lapse. 
It  is  important  to  bear  this  in  mind  in  the  case  of 
4 


50  Examination  of  Insurance  Companies 

those  forms  of  policies  on  which  the  reserve  decreases 
instead  of  increasing,  the  latter  being  the  usual  con- 
dition. On  term  policies  which  cover  a  long  period, 
we  find  that  the  reserve  increases  at  the  beginning  and 
then  decreases  until  at  the  expiration  of  the  policy  the 
reserve  is  zero.  Under  such  a  policy  you,  of  course, 
appreciate  the  danger  of  permitting  the  loan  to  remain 
as  an  asset  after  the  maximum  point  of  the  reserve 
accumulation  has  been  passed. 

In  many  cases  it  is  the  practice  of  companies  to  re- 
quire that  the  interest  on  its  policy  loans  shall  be  paid 
in  advance,  and  in  consequence  there  will  be  a  certain 
amount  of  the  interest  receipts  of  the  company  which 
have  not  been  earned;  proper  provision  for  this  con- 
dition should  be  made  in  the  statement  of  liabilities. 

There  is  another  form  of  policy  loan  which  we  may 
distinguish  from  the  regular  kind  by  calling  it  a  ' '  lien. ' ' 
Liens  arise  in  one  of  two  ways:  if  an  assessment  com- 
pany reincorporate  as  a  legal  reserve  company,  it  may 
give  its  policyholders  the  option  of  paying  adequate 
premiums  in  the  future  either  on  the  basis  of  their 
attained  ages  at  the  time  of  reorganization  or  on  the 
basis  of  their  ages  at  the  time  when  their  original 
assessment  contracts  were  issued,  and  in  the  latter  case 
the  policyholder  must  pay  to  the  company  the  amount 
of  the  reserve  which  would  have  been  accumulated  at 
the  time  of  reorganization  had  he  taken  out  a  level 
premium  contract  from  the  start.  If  the  policyholder 
does  not  wish  to  pay  the  amount  of  the  reserve  in 
cash,  it  will  be  safe  for  the  company  to  accept  a  note 
from  him  for  that  amount,  bearing  interest  at  a  rate 
not  less  than  that  assumed  in  the  calculation  of  the 
reserve.     Should  the  policyholder  prefer  to  pay  his 


Examination  of  Insurance  Companies  51 

premium  at  his  attained  age,  no  lien  note  is  given,  for 
each  premium  payment  is  sufficient  not  only  to  pay  the 
current  mortuary  cost,  but  also  to  accumulate  an  ade- 
quate reserve. 

The  second  manner  in  which  these  liens  may  arise 
is  illustrated  by  the  case  of  a  legal  reserve  company 
which  has  issued  policies  upon  the  yearly  renewable 
term  plan  and  wishes  to  give  its  insured  the  right  to 
change  to  another  form  without  medical  examination 
and  at  the  original  age  at  issue.  Let  us  suppose  that 
the  company  is  working  on  the  basis  of  the  American 
Experience  Table  of  Mortality,  with  interest  at  3V2  per 
cent,  per  annum,  that  the  original  policy  was  for 
$1,000,  issued  at  age  30,  ten  years  ago,  upon  the  yearly 
renewable  term  plan,  and  that  the  policyholder  now 
desires  to  change  to  a  twenty  payment  life  contract. 
If  the  insured  desire  to  pay  the  twenty  payment  life 
premiums,  as  of  age  30,  and  make  only  ten  more  pay- 
ments, it  would  be  safe  for  the  company  to  permit 
him  to  do  this  if  he  would  pay  to  it  $206.47  in  cash 
or  give  a  lien  note  for  that  amount.  ,The  change  to 
any  other  form  of  contract  (calling  for  a  higher  pre- 
mium rate  than  the  original  policy)  could  be  safely 
made  on  the  same  basis,  viz.:  the  giving  of  a  lien  note 
for  the  amount  of  reserve  which  should  have  been 
accumulated  at  the  time  of  exchange. 

A  thing  to  be  noted,  however,  in  the  case  of  liens 
claimed  by  reorganized  assessment  companies  as  assets, 
is  the  nature  of  the  lien.  If  the  policyholder  has  signed 
the  note,  no  question  can  arise  as  to  his  understanding 
of  the  placing  of  an  indebtedness  against  his  contract, 
but  in  some  instances  in  the  past  these  liens  have  been 
created  by  the  enactment  of  a  by-law,  and  the  first 


52  Examination  of  Insurance  Companies 

knowledge  the  insured  or  the  beneficiary  had  of  such  a 
lien  was  obtained  at  the  time  that  the  policy  was  sur- 
rendered or  matured  as  a  death  claim.  In  such  cases 
it  is  necessary  to  carefully  determine  the  legality  of 
the  by-law  and  make  certain  that  the  policyholder  is 
acquainted  with  the  exact  condition  of  affairs.  The 
same  limitation  as  to  their  admissibility  as  an  asset 
applies  to  policy  liens  as  to  policy  loans,  viz. :  they  are 
good  only  when  equal  to  or  less  than  the  reserve. 

A  premium  note  is  a  note  signed  by  the  insured  for 
his  temporary  accommodation  in  order  that  he  may  be 
enabled  to  pay  the  premiums  called  for  by  his  policy 
contract.  As  a  usual  thing  they  run  for  short  terms 
(within  a  year)  and  bear  interest,  for  if  they  are  given 
without  an  interest  requirement,  it  will  be  apparent 
to  you  that  a  discrimination  is  being  worked  against 
the  policyholder  who  pays  his  premium  in  cash  when 
it  becomes  due.  It  is  not  necessary  for  the  policy  to 
be  deposited  with  the  company  when  a  premium  note 
is  given  by  the  insured.  These  remarks  apply  to  the 
premium  notes  given  by  holders  of  life  insurance  con- 
tracts; as  a  usual  thing,  premium  notes  on  other  forms 
of  insurance  contracts  are  admitted  as  assets  without 
reference  to  the  reserve  which  is  being  maintained 
upon  that  particular  policy.  This  treatment  is  con- 
sonant with  the  treatment  of  the  uncollected  pre- 
miums, which  will  be  referred  to  more  at  length  to- 
morrow. 


CHAPTER  VII 

Miscellaneous  Assets  —  Bills  Receivable  —  Furniture 
and  Fixtures  —  Accrued  Interest  —  Rent  Paid  in 
Advance  —  Reinsurance  Due  —  Agents'  Balances  — 
Deferred  Premiums  —  Uncollected  Premiums  — 
"  Paid  for  "  and  "  Written  "  Bases  —  Uncollected 
Assessments  of  Fraternals. 

You  may  find  some  bills  receivable  among  tbe  assets 
of  a  company  which  you  are  examining;  these  are 
nothing  more  or  less  than  notes,  and  being  loans  on 
personal  security  are  disallowed  as  assets.  An  insur- 
ance company  is  not  supposed  to  invest  its  funds  in 
commercial  paper.  To  attempt  to  appraise  an  asset 
of  this  kind  would  require  the  examiner  to  pass  upon 
the  financial  responsibility  of  the  maker  of  each  note, 
and  this  is  manifestly  impossible. 

Furniture  and  fixtures  are  sometimes  included  by 
companies  among  their  ledger  assets,  and  if  so  are 
disallowed,  it  being  impossible  to  properly  appraise 
an  asset  of  this  kind.  It  is  proper  that  at  this  point 
I  should  call  your  attention  to  the  fact  that  it  is  the 
general  practice  of  Insurance  Departments  to  regard 
assets  as  valueless  unless  they  are  marketable  so  they 
may  be  used  in  the  settlement  of  policy  claims,  if 
necessary. 

The  accrued  interest  on  the  various  kinds  of  securi- 
ties and  the  accrued  rents  on  the  property  which  the 
company  owns,  are  items  which  require  no  explanation 
from  me;  their  treatment  is  obvious.    In  some  cases 

[53] 


54  Examination  of  Insurance  Companies 

you  may  be  met  by  the  claim  of  a  company  that  it 
should  be  given  credit  for  the  rents  which  it  has  paid 
in  advance.  If,  for  instance,  on  December  31st,  a  com- 
pany should  have  sent  its  cheque  for  the  January  rent 
of  an  office  which  it  is  occupying  it  might  properly 
claim  credit  for  that  payment ;  there  is  no  question  but 
that  the  claim  is  logical.  We  charge  the  company  with 
a  liability  for  any  rents  (when  it  is  the  tenant)  which 
are  past  due  or  accrued,  and  as  this  is  simply  the 
reverse  of  that  situation,  the  company  should  be  given 
credit  for  any  rents  which  it  has  paid  in  advance.  The 
same  reasoning  applies  to  fire  insurance  premiums 
which  have  been  paid  in  advance,  the  company  being 
entitled  to  credit  for  the  unearned  portion  of  the  pre- 
mium, although  it  is  not  very  usual  for  this  claim  to 
be  made. 

In  the  course  of  your  work  you  may  find  that  a 
credit  is  claimed  for  reinsurance  on  losses  due  from 
other  companies.  These  are  cases  where  other  com- 
panies have  reinsured  some  part  of  the  risk ;  a  loss  has 
been  sustained  and  the  company  which  you  are  exam- 
ining has  not  had  the  opportunity  to  receive  from  the 
reinsuring  company  its  share  of  the  loss.  In  conse- 
quence, it  is  entitled  to  credit  for  any  reinsurance  due 
from  solvent  admitted  companies,  for  either  you  are 
charging  the  full  liability  on  any  losses  which  have 
occurred  or  the  company  which  you  are  examining  has 
paid  the  claim. 

Agents'  debit  balances  are  of  two  kinds:  one  we  find 
in  the  statement  of  life  insurance  companies  and  the 
other  in  statements  of  fire  insurance  companies.  The 
terms  have  two  different  meanings:  in  the  case  of  a 
life    insurance    company,    an    agent's    debit   balance 


ExAMIISrATION    OF    INSURANCE    COMPANIES  55 

refers  to  an  advance  wliich  has  been  made  to  him 
(either  in  cash  or  by  permitting  him  to  retain  pre- 
miums which  he  has  collected)  and  which  is  unsecured 
in  the  sense  that  we  understand  it,  although  the  ad- 
vance may  be  secured  by  the  renewal  contract  of  the 
agent.  In  the  case  of  a  fire  insurance  company  the 
agent's  balance  represents  the  premiums  for  which  he 
has  not  accounted. 

The  cause  of  the  difference  in  these  two  items  arises 
from  the  fact  that  the  two  statements  are  on  different 
bases.  The  statement  of  the  life  insurance  company 
is  upon  a  cash  basis,  and  the  only  items  that  are  con- 
sidered as  premium  income  are  the  premiums  which 
have  been  actually  paid  either  in  cash  or  in  notes ;  in 
the  case  of  a  fire  insurance  company  every  premium, 
as  soon  as  it  is  written,  is  carried  into  the  income 
account. 

According  to  the  annual  statement  blanks  used  by 
departments  the  amount  of  the  ledger  assets  must 
exactly  equal  the  ledger  assets  of  the  previous  year, 
plus  the  income  of  the  year,  less  the  disbursements 
which  have  been  made  during  the  year;  in  consequence, 
the  treatment  of  the  premiums  in  the  case  of  the  fire 
insurance  company  requires  us  to  have  some  corre- 
sponding item  in  the  ledger  assets  to  represent  the  in- 
debtedness of  the  agent.  In  the  case  of  a  life  insur- 
ance company  the  premiums  are  not  carried  into  the 
income  portion  of  the  statement  until  they  have  been 
paid  in  cash,  and  the  uncollected  premiums,  therefore 
are  not  iQcluded  among  the  ledger  assets. 

The  agents'  debit  balances  in  a  fire  insurance  com- 
pany when  not  more  than  ninety  days  past  due  are 
recognized  as  a  good  asset.      The  reason  for  fixing 


56  Examination  of  Insurance  Companies 

three  months  as  a  line  of  demarkation  between  a  good 
asset  and  a  bad  asset  is  entirely  arbitrary.  Those 
who  were  charged  with  the  duty  of  framing  the  stat- 
utes undoubtedly  had  to  rely  upon  their  past  experi- 
ence, and  it  was  probably  felt  that  an  agent  should 
report  premiums  in  his  hands  within  ninety  days  after 
they  had  been  written.  Section  118  of  the  New  York 
Insurance  Law  specifically  provides  for  the  allowances 
of  this  item  when  an  examination  is  made  by  the 
authority  of  the  Superintendent  of  Insurance  into  the 
affairs  of  a  fire  insurance  company,  or  when  a  fire 
insurance  company  renders  a  statement  to  the  Insur- 
ance Department,  for  the  section  states : 

''  There  shall  not  be  allowed  as  assets  any  in- 
vestments which  are  not  held  as  prescribed  by 
law  at  the  date  of  such  examination  or  rendering 
such  statement ;  but  unpaid  premiums  on  policies 
written  within  three  months  shall  be  admitted  as 
available  resources." 

I  merely  wish  to  call  your  attention  to  the  fact  that 
in  the  case  of  life  insurance  companies  the  debit  bal- 
ances of  the  agents  are  really  bills  receivable,  and  the 
same  rule  applies  for  their  disallowance  as  in  the  case 
of  bills  receivable. 

Accident  and  miscellaneous  insurance  companies 
have  still  a  third  form  of  statement.  They  are 
required  to  include  at  the  present  time  among 
V  the  items  of  income  all  premiums  which  have  been 
\>itten,  but  instead  of  charging  them  to  the  agents, 
the>  carry  them  into  the  ledger  assets  as  items  of 
*' preml'^ms  in  course  of  collection;"  the  same  rule 
applies  here  as  in  the  case  of  fire  insurance  companies, 
viz.,  premiums  which  are  not  more  than  ninety  days 


Examination  of  Insurance  Companies  57 

past  due  are  admitted  as  assets.  In  the  case  of  fidelity 
and  surety  companies  this  rule  may  work  an  injustice, 
as  premiums  which  are  perfectly  good  are  sometimes 
by  the  very  terms  of  the  bond  or  the  policy  not  collect- 
ible until  the  contract  is  finished  or  the  estate  has  been 
wound  up  or  until  some  court  proceedings  have  been 
had  which  will  render  the  premium  due.  It  fre- 
quently happens,  therefore,  that  these  premiums  are 
more  than  ninety  days  past  due,  and  while  perfectly 
good,  are  disallowed  as  assets. 

I  wish  to  call  your  attention  to  a  situation  which  I 
found  in  the  case  of  a  casualty  company  which  had  a 
great  number  of  premiums  more  than  ninety  days  past 
due;  in  order  to  obtain  credit  for  some  of  them  as  an 
asset  it  asked  its  agents  to  give  cheques  to  the  com- 
pany, but  the  cheques  were  not  dated  until  some  con- 
siderable time  after  the  annual  statement  date.  In  the 
mean  time  they  were  carried  in  the  cash  drawer  as 
*'  cash  in  office."  It  is  unnecessary  for  me  to  point 
out  the  impropriety  of  this  method  of  converting  a 
nonadmitted  asset  into  an  admitted  one,  and,  of 
course,  these  post-dated  cheques  were  disallowed. 

In  life  insurance  companies,  items  of  deferred  pre- 
miums require  some  explanation.  A  deferred  premiimi 
is  the  semi-annual  or  quarterly  installment  due  after 
the  date  of  the  examination  for  the  balance  of  the  pre- 
miums necessary  to  complete  the  policy  year.  In  other 
words,  if  a  policy  be  issued  in  December  of  one  year 
on  the  semi-annual  basis,  the  second  installment  of  the 
premium  will  be  due  in  June  of  the  next  year.  If  you 
are  making  an  examination,  therefore,  as  of  December 
31st,  there  will  be  one  semi-annual  premium  deferred, 
viz.,  the  premium  which  is  due  in  the  following  June. 


58         Examination"  of  Insurance  Companies 

I  have  prepared  a  table  which  shows  how  the  install- 
ments  on  both  semi-annual  and  quarterly  policies  are 
deferred.  At  the  top  of  the  table  is  indicated  the  date 
of  the  examination.  All  of  the  premiums  found  to  the 
right  of  the  heavy  line  are  the  ones  which  will  be  de- 
ferred. For  instance,  by  Table  I,  which  is  applicable 
to  an  examination  made  as  of  December  31st,  you  will 
see  that  on  any  policy  with  semi-annual  premiums 
issued  before  July,  there  is  no  deferred  premium, 
because  the  premiums  for  the  entire  policy  year  will 
have  become  due  before  the  time  of  the  examination. 
A  policy,  however,  which  is  issued  in  July  of  that  year, 
will  have  its  second  installment  due  in  January  of  the 
next  year,  and  in  consequence  there  will  be  one  semi-an- 
nual premium  deferred.  In  the  same  way  a  policy  issued 
in  November  on  the  same  basis  will  have  one  deferred 
premium  —  the  installment  due  the  following  May. 
In  the  case  of  quarterly  policies,  you  will  notice  that 
policies  issued  in  the  months  of  January,  February 
and  March  have  no  deferred  premiums  because  all 
four  quarterly  installments  become  due  before  the 
date  of  the  examiaation,  December  31st;  a  policy 
which  is  issued  during  April,  May  or  June  will  have 
one  quarterly  premium  deferred;  a  policy  issued 
during  July,  August  or  September  will  have  two 
quarterly  premiums  deferred;  a  policy  issued  during 
October,  November  or  December  will  have  three  quar- 
terly premiums  deferred. 


Examination  of  Insurance  Companies  59 

TABLE  I 

Examination  as  of  December  31st 

Semi-annual  Premiums 

Iseues  of  January July 

"       "  February August 

"       "  March September 

"       "  April October 

"       "  May November 

"       "  June December 

"      "  July 

"  August 

"       "  September 

«       "  October 

"       "  November 

"       "  December 


January 

February 

March 

April 

May 

June 


Quarterly  Premiums 

Issues  of  January April July October 

"       "  February May August November 

"       "  March June September December 

"       "  April July October . . . 

"       "  May August November 

"       "  June September December . 

"       "  July October 

"       "  August November.  . 

"       "  September December.  . 


January 

February 

March 


January April 

February May 

March June 

October I  January April July 

"       "  November. ...  I  February May August 

"       "  December .  . . .  |  March June September 

In  order  that  you  may  see  how  this  rule  works  in 
the  case  of  an  examination  made  at  some  other  date, 
I  have  prepared  Table  II,  which  shows  the  deferred 
premiums  which  are  to  be  found  when  an  examination 
is  made  as  of  October  31st.  You  will  note  there  that 
the  months  of  issue  (the  months  which  appear  on  the 
left  of  the  table)  are  arranged  in  a  different  order 
and  all  of  the  installments  to  the  right  of  the  heavy 
line  are  ones  which  will  be  deferred.  For  instance, 
any  policy  with  semi-annual  premiums  issued  between 
November  1st  and  April  30th,  will  have  no  deferred 
premiums,  while  semi-annual  policies  issued  between 
May  1st  and  October  31st  will  have  one  semi-annual 
premium  deferred. 


60         Examination  of  Insurance  Companies 

TABLE  II 
Examination  as  of  October  sist 

Semi-annual  Premiums 

Issues  of  November May 

"       "  December June 

"       "  January July 

"       "  February August 

"       "  March September 

"       "  April October 

"       "  May INovember 

"       "  June December 

"       "  July January 

"       "  August February 

"       "  September March 

"       "  October April 

Quarterly  Premiums 

Issues  of  November. . . .     February May August 

"  "  December.  . . .     March Jime September 

"       "  January April July October 

"       "  February May August. . . 

"       "March June September 

"       "April July October.  . 

"       "  May August 

"       "June September.. 

"       "  July October.... 


November 
December 

January 

November February 

December March 

January April 


"       "  August I  November February May 

"       "  September I  December March June 

"       "  October |  January April July 

In  preparing  a  schedule  of  deferred  premiums  it  is 
important  to  note  whether  a  policyholder  has  paid  any 
of  the  installments  before  they  became  due,  because  if 
he  has,  it  will  be  necessary  to  remove  that  installment 
from  the  schedule  of  deferred  premiums. 

Uncollected  premiums  (premiums  in  course  of  collec- 
tion) may  be  either  annual,  semi-annual  or  quarterly. 
The  term  refers  only  to  the  premiums  which  have 
fallen  due  before  the  date  of  the  examination  and  upon 
which  the  agent  has  not  reported  the  collection  or  the 
cancellation  to  the  home  office.  The  uncollected  pre- 
miums have  nothing  to  do  with  the  method  of  pay- 
ment, i.  e.,  they  may  be  either  annual,  semi-annual  or 
quarterly  installments.    A  policy  may  have  credits  for 


Examination  of  Insukance  Companies  61 

both  an  uncollected  and  a  deferred  premium,  and  I 
think  you  will  be  able  to  see  that  the  uncollected  pre- 
miums sometimes  include  those  installments  on  semi- 
annual and  quarterly  policies  which  became  due  before 
the  date  of  the  examination,  but  which  had  not  been 
reported  by  the  agent. 

Annual  statements  are  required  in  the  different 
States  upon  two  bases:  one  the  ''  paid  for  basis  "  and 
the  other  the  ''  written  basis."  The  former  requires 
companies  to  report  only  those  policies  in  force  which 
have  had  the  first  premium  paid  by  the  insured;  the 
latter  basis  requires  companies  to  report  all  policies  as 
soon  as  they  are  written  and  which  remain  uncancelled 
upon  their  books.  I  mention  this  fact  to  you  now  be- 
cause it  has  a  direct  bearing  upon  the  way  in  which 
the  schedules  of  uncollected  and  deferred  premiums  are 
prepared.  In  the  "  paid  for  "  States,  the  schedule 
naturally  will  not  contain  a  number  of  items  which 
will  be  found  in  the  schedule  prepared  on  the  other 
basis.  I  wish  to  call  your  attention,  however,  to  the 
fact  that  a  statement  may  be  prepared  on  the  paid  for 
basis,  but  contain  a  small  amount  of  uncollected  first 
year's  premiums,  although  you  would  naturally  expect 
that  upon  this  basis  no  uncollected  first  year  pre- 
miums would  be  included;  the  explanation  may  be 
found  in  the  fact  that  the  items  in  question  are  the 
second  semi-annual  or  the  second,  third  or  fourth 
quarterly  installments  of  first  year  premiums,  and  the 
company,  of  course,  cannot  cancel  the  policy  until 
after  the  days  of  grace  have  expired;  if  those  days 
of  grace  carry  the  policy  beyond  the  date  of  the  exam- 
ination, the  schedule  will  show  uncollected  first  year 
premiums. 


62  Examination  of  Insukance  Companies 

In  the  case  of  fraternal  organizations,  another 
method  is  followed.  You  will  not  find  credit  allowed 
for  uncollected  or  deferred  premiums,  but  you  will  find 
that  included  among  the  non-ledger  assets  are  ' '  assess- 
ments actually  collected  by  subordinate  lodges  not  yet 
turned  over  to  supreme  lodge."  As  the  fraternals  do 
not  ordinarily  issue  certificates  which  provide  for  the 
payment  for  a  longer  period  than  the  current  month, 
there  can  be  no  such  thing  as  a  deferred  premium,  and 
the  item  which  I  have  just  quoted  is  the  equivalent 
allowance  which  is  made  in  order  that  the  fraternal 
organization  may  receive  credit  for  any  premiums  in 
course  of  transmission.  " 


CHAPTER  VIII 

Loading  on  Uncollected  and  Deferred  Premiums  — 
Disallowed  or  Non-admitted  Assets  —  Loans  on  Cap- 
ital Stock  —  Supplies  and  Printed  Matter  —  Com- 
muted Commissions  —  Cash  Advanced  to  Officers  — 
Excess  Credits  —  Depreciation  in  Securities  —  Pre- 
miums Outstanding  More  than  Ninety  Days  — 
Appreciation. 

I  spoke  yesterday  morning  of  the  credit  which 
should  be  allowed  a  life  insurance  company  for  the 
uncollected  and  deferred  premiums  outstanding  at  the 
time  of  the  examination;  it  is  but  proper  to  allow  these 
as  credits,  for  the  calculation  of  the  reserve  is  upon 
the  assumption  that  all  of  the  premiums  are  paid  at  the 
beginning  of  the  policy  years. 

It  is  not  proper,  however,  to  allow  the  entire  amount 
of  the  uncollected  and  the  deferred  premiums  as  an 
asset,  for  the  reserve  is  calculated  upon  the  net  pre- 
mium basis.  You  will  recall  that  the  premium  which  a 
policyholder  is  called  upon  to  pay,  is  divided  into  two 
parts:  first,  the  mathematical  net  premium  which  is 
sufficient  to  pay  the  current  mortuary  cost  and  accumu- 
late the  reserve,  and  second,  the  loading  which  is 
added  to  the  net  premium  in  order  that  the  expenses 
may  be  provided  for,  the  fluctuations  in  market  values 
taken  care  of,  and  to  provide,  in  short,  for  everything 
except  the  mortality  and  the  reserve.  Since  the  re- 
serve is  calculated  upon  a  net  basis  (with  no  regard 

[63] 


64         Examination  of  Insurance  Companies 

for  the  loading)  the  asset  which  we  are  going  to  allow 
as  an  offset  should  be  placed  upon  the  same  basis. 

In  consequence,  it  becomes  necessary  to  deduct  from 
the  uncollected  and  deferred  premiums,  the  element  to 
which  I  have  just  referred  —  the  loading.  Nearly  all 
forms  of  legal  reserve  policies  have  their  premiums 
computed  upon  one  of  three  bases:  the  regular  level 
premium,  upon  which  the  loading  is  the  same  through- 
out the  entire  history  of  the  policy  contract,  or  the  full 
preliminary  term,  the  premiums  on  which  for  the  first 
year  are  for  one  year  term  insurance,  or  the  modified 
preliminary  term.  The  net  premium  for  the  first  year 
of  the  second  basis  just  mentioned  —  the  full  prelimi- 
nary term  —  is  that  of  a  one  year  term  insurance,  and 
the  difference  between  it  and  the  gross  premium 
charged  to  the  insured,  is  the  loading,  which  is,  there- 
fore, very  heavy,  amounting  to  about  75  or  80  per  cent, 
of  the  premium  charged,  while  the  net  premium  there- 
after is  uniform  and  dependent  upon  the  form  selected 
by  the  insured.  The  net  premium  for  the  first  year  of 
the  third  basis  —  the  modified  preliminary  term  — 
contains  another  factor  which  makes  the  net  premium 
larger  than  the  one  just  mentioned  and  the  loading  in 
consequence  smaller,  although  in  the  subsequent  years 
the  loadings  on  this  basis  are  larger  than  on  the  full 
preliminary  term  basis.  All  of  these  facts  must 
be  borne  in  mind  when  fixing  upon  the  proper  deduc- 
tion to  be  made  from  the  uncollected  and  deferred 
premiums. 

Having  mentioned  practically  all  of  the  sources  of  a 
company's  assets,  I  shall  briefly  refer  to  some  of  the 
items  of  disallowed  or  non-admitted  assets,  which  in 
the  case  of  Insurance  Department  examinations  are 
always  taken  into  account. 


Examination  of  Insurance  Companies  65 

The  company  under  examination  is  never  given 
credit  for  any  of  its  capital  stock  which  it  may  own 
or  any  loans  which  it  has  made  upon  it  as  the  security. 
The  reason  for  this  is  obvious;  the  capital  stock  is 
intended  to  serve  as  an  additional  investment  for  the 
protection  of  the  claims  of  the  policyholders:  the  in- 
vestment of  the  capital  stock  is  hedged  around  with 
even  greater  restrictions  than  apjjly  ordinarily  to  the 
other  assets  of  a  company,  and  you  will,  therefore,  see 
the  impropriety  of  permitting  a  company  to  invest  its 
funds  in  its  own  capital  stock.  This  is  equivalent  to  a 
man  trying  to  lift  himself  by  his  own  boot  straps. 

It  may  be  pertinent  for  me  at  this  point  to  call  your 
attention  to  the  fact  that  insurance  companies  and 
banking  institutions  are  the  only  two  classes  of  corpo- 
rations which  are  not  permitted  to  use  any  of  their 
capital  stock  for  the  purpose  of  establishing  their  busi- 
ness. In  every  other  class  of  corporation,  that  occurs 
to  me  at  the  present  time,  the  supposition  is  that  the 
company  will  use  its  capital  stock  for  the  purpose  of 
establishing  itself  and  building  up  the  plant  which  is 
necessary  for  the  conduct  of  its  business.  In  the  case 
of  an  insurance  company  this  is  not  permitted;  all  of 
the  preliminary  expenses  of  the  organization,  the 
establishment  of  agencies  and  the  purchases  of  sup- 
plies must  be  met  at  first  from  the  surplus  which  re- 
sults from  the  selling  of  the  capital  stock  of  the  com- 
pany above  par.  This  is  a  natural  result  of  the  practice 
of  charging  the  capital  stock  of  an  insurance  company 
as  a  liability  without  permitting  it  to  consider  its 
plant  as  an  asset.  If,  for  instance,  an  insurance  com- 
pany should  start  and  sell  its  capital  stock  at  par  only, 
5 


66  Examination  op  Insurance  Companies 

the  moment  that  it  bought  and  used  a  postage  stamp 
its  capital  would  be  impaired. 

Supplies,  stationery  and  printed  matter  are  in  the 
same  category  as  furniture,  fixtures  and  safes.    "While 
they  may  cost  an  insurance  company  a  great  deal  of 
money  they  are  not  readily  convertible  into  cash  and 
are,  therefore,  not  available  for  use  in  the  payment  of 
its  losses.     They  are,  therefore,  disbursements  which 
must  be  met  from  the  surplus  portion  of  the  assets  in 
order  that  the  capital  stock  may  remain  unimpaired. 
Commuted    commissions    are    really    advances    to 
agents  or  agents'  debit  balances  in  the  case  of  a  life 
insurance  company.    They  are  purchases  of  the  future 
renewal  interests  of  the  agents,  and  we  have  no  guar- 
antee that  the  renewal  premiums  will  ever  be  paid  by 
the  insured ;  as  the  payment  of  renewal  commissions  is 
based  upon  the  receipt  of  the  renewal  premiums  from 
the  insured,  it  is  manifest  that  the  security  behind  this 
debt  is  not  of  the  kind  which  can  be  recognized  as 
an  asset. 

Cash  advanced  to  or  in  the  hands  of  officers  or 
agents  is  a  form  of  asset  which  is  always  disallowed. 
You  will  readily  appreciate  that  it  does  not  differ  from 
the  loans  on  personal  security  or  bills  receivable  to 
which  I  have  already  referred,  and  the  examiner  can- 
not be  expected  to  pass  upon  the  financial  responsi- 
bility of  the  representative  of  the  company  in  whose 
hands  cash  belonging  to  it  has  been  placed. 

A  very  important  matter  (especially  in  the  case  of 
newly  established  life  insurance  companies)  is  the  ex- 
cess over  the  reserve  which  results  from  the  premium 
notes,  policy  loans,  liens,  uncollected  and  deferred  pre- 
miums and  other  credits  which  are  claimed  by  the 
company   on   account   of  its   policy   contracts.     The 


Examination  of  Insurance  Companies  67 

proper  way  to  compute  this  excess  item  is  by  the 
preparation  of  a  schedule  similar  to  the  one  with 
which  you  are  familiar  (see  Appendix  H),  and  which 
serves  to  bring  out  clearly  the  nature  of  this  disallow- 
ance. Against  each  policy  is  placed  the  various  credits 
which  are  claimed  upon  its  account  and  the  sum  of 
these  credits  is  compared  with  the  liability  which  the 
company  is  maintaining  to  take  care  of  this  particular 
policy.  The  headings  of  the  various  columns,  I  am 
sure,  are  familiar  to  you  and  need  not  receive  any  fur- 
ther explanation  from  me.  You  will  note,  however, 
that  in  computing  the  total  amount  of  credits  claimed 
for  any  particular  policy,  I  have  included  only  the  net 
amount  of  uncollected  and  deferred  premiums;  as  we 
deduct  the  loading  before  computing  the  assets,  it  is 
but  just  to  the  company  to  charge  it  only  with  that 
portion  of  the  uncollected  and  deferred  premiums 
which  is  allowed. 

In  the  schedule  described  in  the  foregoing  remarks 
you  will  note  that  each  policy  is  treated  separately, 
and  it  would  be  improper  to  allow  the  accounts  of 
the  various  policies  to  be  mingled.  If,  for  instance, 
a  company  maintained  upon  one  policy  a  reserve  of 
$10  more  than  the  sum  of  the  credits  which  it  claimed 
upon  that  policy,  and  upon  anotlier  policy  claimed  as 
an  asset  $10  more  than  the  reserve  which  it  main- 
tained against  that  contract,  it  would  be  improper  to 
consider  that  one  transaction  offsets  the  other  and  that 
no  deduction  was  necessary.  An  analagous  situation 
would  be  created  if  we  assumed  that  because  the  se- 
curity behind  one  mortgage  was  worth  $10  more  than 
the  amount  loaned  thereon,  and  the  security  behind 
another   one   was   worth   $10   less   than   the   amount 


68  Examination  of  Insurance  Companies 

loaned,  the  transactions  counterbalance  one  another. 
The  false  reasoning  contained  in  this  proposition  must 
be  obvious  to  you. 

The  book  value  of  ledger  assets  over  the  market 
value  is  an  item  which  is  always  deducted.  The  source 
of  this  deduction  may  be  traced  to  one  of  many  causes. 
If,  for  instance,  the  company  own  real  estate  which 
has  depreciated  from  the  figure  at  which  it  is  carried 
on  the  books,  the  difference  between  the  market  value 
at  the  time  of  the  examination  and  the  price  at  which 
the  parcel  is  carried  upon  the  company's  books  would 
be  deducted;  if  the  company  has  loaned  money  on  a 
piece  of  property  which  the  reports  of  the  appraisers 
show  is  not  worth  the  amount  loaned  upon  it,  the  dif- 
ference would  appear  here,  and  it  is  independent  of 
any  instructions  which  might  be  issued  by  the  super- 
vising officer  relative  to  the  necessity  for  a  reduction 
in  the  amount  of  the  outstanding  principal  at  some 
early  date  in  the  future;  if  the  collateral  deposited  as 
the  security  for  a  collateral  loan  is  insufficient  to 
maintain  the  loan,  the  deficiency  is  taken  care  of  in 
this  item,  and  if  the  market  value  of  the  bonds  and 
stocks  is  less  than  the  amount  at  which  those  securi- 
ties are  carried  on  the  books  of  the  company,  the  de- 
ficiency must  be  deducted.  In  a  subsequent  talk  I 
shall  refer  more  to  the  method  of  determining  the 
proper  book  value  at  which  the  bonds  of  a  company 
should  be  carried,  and  this  will  have  a  bearing  upon 
the  matter  of  depreciation  which  we  are  now  con- 
sidering. 

In  the  case  of  fire  insurance  and  companies  trans- 
acting what  is  broadly  termed  "  miscellaneous  "  busi- 
ness, I  have  previously  called  your  attention  to  the 


Examination  of  Insukance  Companies  69 

fact  that  premiums  in  course  of  collection  more  than 
ninety  days  past  due  or  agents'  balances  upon  busi- 
ness which  was  written  more  than  ninety  days  before 
the  date  of  the  examination,  are  disallowed  as  assets. 
It  may  not  be  amiss  for  me  to  call  your  attention  to 
the  fact  that  while  I  have  referred  to  the  necessity  for 
deducting  from  the  assets  any  excess  which  their  book 
value  has  over  the  market  value,  the  contrary  situa- 
tion must,  of  course,  be  provided  for,  i.  e.,  if  we  should 
find  that  any  of  the  assets  of  the  company  are  worth 
more  in  the  market  to-day  than  the  figure  at  which 
they  are  carried  in  the  books  of  the  company,  we 
should  allow  it  credit  for  that  excess  value. 


CHAPTER  IX 

Amortization  of  Bonds  Purchased  Above  Par  —  Accu- 
mulation of  Bonds  Purchased  Below  Par  —  Incor- 
rect Methods  of  Treating  Premiums  and  Discounts 
—  Necessary  Factors. 

In  my  talk  to  you  yesterday  I  referred  to  the  fact 
that  the  appreciation  and  depreciation  in  the  book 
values  of  the  ledger  assets  should  be  taken  into  ac- 
count when  we  are  preparing  a  statement  showing  the 
financial  condition  of  a  company.  It  must  be  apparent 
to  you  that  an  investor  who  intends  to  hold  securities 
until  they  mature  is  not  concerned  with  any  fluctua- 
tions in  the  market  value  of  the  securities ;  he  is  inter- 
ested only  in  the  income  earning  powers  of  his  invest- 
ment. In  other  words,  if  an  investor  should  buy  a 
bond  at  par  with  the  intention  of  holding  it  until  the 
principal  should  become  due,  he  would  not  be  affected 
by  any  abnormal  conditions  in  the  stock  market  which 
might  temporarily  cause  his  bond  to  be  worth  98  or 
105;  unless  he  sold  his  bond  at  the  current  market 
price,  the  temporary  fluctuations  would  not  affect  him 
at  all. 

A  life  insurance  company  is  in  the  same  situation  as 
an  investor  such  as  I  have  just  described.  Its  policy 
contracts  run  for  a  long  term  of  years  and  the  calcula- 
tion of  its  premiums  is  based  upon  its  ability  to  earn 
a  certain  rate  of  interest  on  its  invested  assets;  it  is 
not  desirable  that  an  insurance  company  should  con- 

[70] 


Examination  of  Insura.nce  Companies  71 

stantly  change  its  investments,  for  that  process  leads 
to  manipulation  and  the  injection  of  the  element  of 
speculation  into  its  operations,  conditions  which  were 
responsible  for  many  of  the  evils  which  were  devel- 
oped in  recent  investigations  of  insurance  companies. 
For  these  reasons  a  life  insurance  company  should 
attempt  to  secure  safe  investments  running  for  long 
terms,  and  it  will,  therefore,  be  concerned  more  with 
receiving  the  principal  of  its  investments  when  they 
mature  and  receiving  the  proper  interest  rate  in  the 
meanwhile,  than  with  any  temporary  changes  in  the 
market  value  of  the  securities. 

The  question  of  the  receipt  of  the  par  value  of  a 
bond  at  its  maturity  brings  us  face  to  face  with  the 
proper  method  of  taking  care  of  the  bonds  which  have 
been  bought  on  different  bases.  The  three  possible 
situations  are,  first,  that  a  bond  shall  have  been 
bought  at  par  or,  second,  that  it  has  been  bought  above 
par  or,  third,  that  it  has  been  bought  below  par.  In 
order  to  illustrate  these  different  conditions  let  us 
assume  that  in  each  of  the  first  two  cases  the  bond 
is  for  $1,000,  is  purchased  on  June  1,  1910,  bears  inter- 
est at  a  rate  of  5  per  centum  per  annum,  that  the 
interest  is  payable  semi-annually  on  June  1st  and  De- 
cember 1st,  and  that  the  bond  will  mature  (its  prin- 
cipal become  due)  on  June  1,  1915. 

It  will  be  apparent  to  you  that  if  the  bond  be  pur- 
chased at  par,  each  of  the  $25  coupons  will  be  interest 
on  the  investment  and  on  June  1,  1915,  the  owner 
will  receive  the  amount  which  he  originally  invested, 
$1,000. 

The  second  case  is  illustrated  by  a  bond  similar  to 
the  one  described,  being  purchased  at  $1,044.91;  in 


72  Examination  of  Insura.nce  Companies 

other  words,  at  a  premium  of  $44.91,  or,  to  use  the 
terms  of  the  bond  market,  has  been  purchased  "  at  " 
104.491,  or  has  been  purchased  ' '  on  a  4^  basis. ' '  The 
latter  designation  is  used  in  order  to  convey  the  infor- 
mation that  an  investor  paying  that  price  for  the  bond 
indicated,  will  receive  only  4  per  cent,  on  his  invest- 
ment, instead  of  5  per  cent,  as  called  for  by  the  bond. 
The  correctness  of  this  statement  will  be  shown  later. 

The  investor  has  paid  $1,044.91,  and  on  June  1, 
1915,  will  receive  only  $1,000  for  the  surrender  of  the 
bond;  it  is  quite  evident,  therefore,  that  if  he  is  not 
to  suffer  some  loss  he  must  provide  in  some  way  for 
the  gradual  writing-off  of  this  premium  of  $44.91  dur- 
ing the  five  years,  from  the  interest  receipts,  i.  e.,  he 
must  use  some  part  of  each  $25  which  he  receives,  for 
the  purpose  of  reducing  the  premium  which  he  was 
compelled  to  pay  on  the  bond,  so  that  when  it  matures 
he  will  have  only  $1,000  invested.  The  scientific 
application  of  this  process  is  called  amortisation. 

In  the  past,  some  companies  have  used  one  of  two 
methods  to  accomplish  this,  but  both  are  incorrect, 
and  yield  improper  results.  I  shall  briefly  refer  to 
them  in  order  that  you  may  understand  the  nature  of 
the  errors.  In  the  case  of  the  bond  just  referred  to, 
one  of  the  methods  was  to  charge  the  premium  of 
$44.91  to  profit  and  loss  as  soon  as  the  bond  was  pur- 
chased; in  consequence,  the  earnings  for  that  year 
showed  an  apparent  loss  and  the  interest  earnings  of 
subsequent  years  were  unduly  inflated.  The  second 
method  was  the  reverse  of  this,  made  no  charge  in 
the  book  value  of  the  security  until  June  1,  1915, 
when  it  charged  profit  and  loss  with  $44.91,  the  differ- 
ence between  the  book  value  of  the  bond  and  the 


Examination  of  Insurance  Companies  73 

amount  which  was  paid,  in  the  meanwhile  considering 
each  coupon  of  $25  as  an  interest  receipt. 

I  have  indicated  to  you  that  the  proper  method  of 
treating  this  situation  is  to  divide  each  interest  pay- 
ment into  two  parts,  carrying  one  to  the  interest 
account  and  the  other  to  a  sinking  fund  which  is  to 
be  used  for  the  wiping  out  of  the  premium  of  $44.91. 
This  method  is  required  by  a  statute  in  the  State  of 
New  York  (see  Appendix  I),  and  while  the  statute 
would  seem  to  be  broad  enough  to  include  within  its 
provisions  companies  transacting  any  kind  of  insur- 
ance business,  it  is  apparently  the  intention  of  the 
Department  to  insist  upon  the  rule  being  observed  by 
life  insurance  companies  only. 

In  order  that  you  may  see  the  exact  manner  in 
which  this  process  is  worked  out,  I  have  prepared  a 
chart  which  indicates  the  various  steps  in  the  bond 
under  consideration.  By  reference  to  the  bond  tables 
in  common  use,  it  will  be  found  that  a  5  per  cent,  bond 
running  for  five  years  will,  if  purchased  at  104.491, 
yield  4  per  cent.,  and  the  following  calculation  proves 
that  to  be  correct:  2  per  cent,  of  $1,044.91  =  $20.90. 
Each  coupon  of  $25,  therefore,  must  be  divided  into 
two  parts,  $20.90  representing  the  interest  earning  and 
$4.10  representing  the  semi-annual  contribution  to  the 
sinking  fund;  the  following  table  will  enable  you  to 
trace  the  progress  of  the  successive  contributions  of 
$4.10: 

Coupon  due  December  1,  1910 $4.10 

Interest  factor X     1 .  02 

Value  June  1,  1911 $4.18 

Coupon  due  June  1,  1911 -f     4.10 

$8.28 


74  Examination  of  Insurance  Companies 

Amount  carried  forward $8 .  28 

Interest  factor X     1 .02 

Value  December  1,  1911 $8.45 

Coupon  due  December  1,  1911 +    4.10 

$12.55 
Interest  factor X     1 .  02 

Value  June  1,  1912 $12 .  80 

Coupon  due  June  1,  1912 -f     4 .  10 

$16.90 
Interest  factor X     1 .  02 

Value  December  1,  1912 $17.24 

Coupon  due  December  1,  1912 +     4 .  10 

$21.34 
Interest  factor X     1 .  02 

Value  June  1,  1913 $21'.  77 

Coupon  due  June  1,  1913 -f     4 .  10 

$25.87 
Interest  factor X     1 .  02 

Value  December  1,  1913 $26.39 

Coupon  due  December  1,  1913 -f     4.10 

$30.49 
Interest  factor X     1 .  02 

Value  June  1,  1914 $31 .  10 

Coupon  due  June  1,  1914 -\-    4. 10 

$35.20 
Interest  factor X     1 .  02 

Value  December  1,  1914 $35.90 


Examination  of  Insurance  Companies 


75 


$35.90 
+     4.10 


$40.00 
X  1.02 

$40.80 
+  4.10 

$44.90 

Amount  carried  forward 

Coupon  due  December  1,  1914 

Interest  factor 

Value  June  1,  1915 

Coupon  due  June  1,  1915 .... 

Premium  on  bond 


From  this  table  you  will  see  that  if  we  accumulate 
the  contributions  to  the  sinking  fund  at  the  rate  of 
4  per  cent,  per  annum,  compounded  semi-annually,  we 
shall  have  a  sufficient  amount  in  the  sinking  fund  to 
take  care  of  the  premium  which  was  paid  on  the  bond 
when  it  was  purchased.  The  difference  of  one  cent 
in  the  result  is  due  to  disregarding  mills  in  the  fore- 
going calculations. 

In  order  that  you  may  note  that  by  this  result  an 
investor  is  at  all  times  receiving  interest  upon  the 
book  value  of  the  bond  at  the  rate  of  4  per  cent,  per 
annum,  we  may  put  the  foregoing  calculations  in 
another  form,  as  follows: 


DATE 

(1) 


Coupon 

(nominal 

interest 

rate) 

(2) 


4%  of  book 

value 

(effective 

rate) 

(3) 


Amorti- 
zation 
factor 

(4) 


Book 
value 

(5) 


December  1,  1910. 

Junel,  1911 

December  1,  1911. 

Junel,  1912 

December  1,  1912. 

Junel,  1913 

December  1,  1913. 

Junel,  1914 

December  1,  1914. 
Junel,  1915 


$25.00 
25.00 
25.00 
25.00 
25.00 
25.00 
25.00 
25.00 
25.00 
25.00 


$20.90 
20.82 
20.73 
20.65 
20.56 
20.47 
20.38 
20.29 
20.19 
20.10 


$4.10 
4.18 
4.27 
4.35 

4.44 


$1,040.81 
1,036.63 
1,032.36 
1,028.01 
1,023.57 
1.019.04 
1,014.42 
1,009.71 
1,004.90 
1,000.00 


Total. 


$44.91 


76  Examination  of  Insurance  Companies 

You  will  note  that  as  a  result  of  deducting  $4.10 
from  the  book  value  of  the  bond  on  December  1,  1910, 
the  new  book  value  is  $1,040.81;  2  per  cent,  of  that 
value  is  $20.82,  which  deducted  from  the  proceeds  of 
the  coupon  received  on  June  1,  1911,  or  $25,  leaves 
$4.18,  as  the  amount  to  be  deducted  in  order  to  obtain 
the  new  book  value.  By  reference  to  the  original  table 
you  will  see  that  the  difference  between  the  amount 
of  the  fund  on  June  1,  1911,  $8.28,  and  the  amount  of 
the  fund  at  the  end  of  the  previous  period,  $4.10=^. 
$4.18.  If  we  take  2  per  cent,  of  the  new  book  value, 
$1,036.63,  we  shall  have  $20.73,  which  deducted  from 
$25  gives  us  $4.27  as  the  amortization  factor,  which 
you  will  be  able  to  identify  on  the  first  table  as  the 
difference  between  $12.55  and  $8.28,  etc. 

At  the  end  of  each  six  months,  therefore,  if  we 
decrease  the  book  value  of  the  bond  by  the  amount 
shown  in  column  (4)  at  the  maturity  of  the  bond  the 
amount  which  will  be  paid  to  us  will  exactly  equal  the 
book  value,  and  the  premium  has  disappeared.  The 
weak  point  of  this  accounting  is  that  we  are  compelled 
to  assume  that  the  sinking  fund  will  earn  the  rate 
of  interest  assumed,  in  the  above  case  4  per  cent.;  it 
might  be  difficult  to  invest  small  funds  in  this  way, 
but  in  actual  practice  the  sinking  fund  will  contain 
sufficient  money  to  enable  an  advantageous  investment 
to  be  obtained. 

For  the  purpose  of  illustrating  the  third  condition 

—  that  of  a  bond  which  has  been  purchased  below  par 

—  let  us  assume  that  the  bond  is  for  $1,000,  is  pur- 
chased on  June  1,  1910,  bears  interest  at  the  rate  of 
3  per  centum  per  annum,  that  the  interest  is  payable 
semi-annually  on  June  1st  and  December  1st,  and  that 


ExaminatiojSt  of  Insurance  Companies 


77 


the  bond  will  mature  on  June  1,  1915.  The  premises 
in  this  assumption  have  been  changed  from  those  in 
the  preceding  one  to  make  them  fit  more  nearly  the 
actual  conditions  which  we  would  expect  in  a  security 
purchased  by  a  life  insurance  company,  for  it  is  not 
to  be  expected  that  5  per  cent,  bonds  will  normally 
sell  below  par. 

If  the  foregoing  bond  be  purchased  for  $955.09,  it 
will  yield  the  purchaser  4  per  cent,  on  his  investment, 
although  the  nominal  rate  stated  in  the  bond  is  only 
3  per  cent.  A  table  constructed  for  this  security, 
similar  to  the  one  just  shown  for  the  bond  purchased 
at  a  premium,  would  be  as  follows: 


DATE 

(1) 


Coupon 

(nominal 

interest 

rate) 

(2) 


4%  on  book 

value 

(effective 

rate) 

(3) 


Accumu- 
lation 
factor 

(4) 


Book 
value 

(5) 


December  1,  1910. 

June  1,  1911 

December  1,  1911. 

June  1,  1912 

December  1,  1912. 

June  1,  1913 

December  1,  1913. 

June  1,  1914 

December  1,  1914. 
June  1,  1915 


Total, 


$15.00 
15.00 
15.00 
15.00 
15.00 
15.00 
15.00 
15.00 
15.00 
15.00 


$19.10 
19.18 
19.27 
19.35 
19.44 
19.53 
19.62 
19.71 
19.81 
19.90 


$4.10 
4.18 
4.27 
4.35 
4.44 
4.53 
4.62 
4.71 
4.81 
4.90 


$44.91 


$959.19 
963.37 
967.64 
971.99 
976.43 
980.96 
985.58 
990 . 29 
995.10 
1,000.00 


You  will  note  that  the  factors  in  column  (4)  are 
called  in  this  case  "  accumulation  factors  "  instead  of 
*'  amortization  factors,"  for  instead  of  reducing  the 
book  value  to  par  by  amortization,  we  are  gradually 
advancing  the  book  value  to  par  by  accumulations.  I 
have  assumed  in  this  case  a  bond  which  would  be  pur- 
chased at  a  price  to  yield  the  same  rate  of  interest  as 


78  Examination  op  Insurance  Companies 

was  yielded  in  the  first  case  in  order  that  you  might 
note  the  fact  that  the  amortization  factors  in  one  case 
are  exactly  the  same  as  the  accumulation  factors  in 
the  other,  but  in  the  first  case  they  are  deducted  from 
the  book  value,  while  in  the  second  case  they  are 
added  to  the  book  value. 

The  foregoing  is  the  process  which  every  life  insur- 
ance company  should  apply  to  its  bonds;  it  is  not  so 
important  that  companies  transacting  other  forms  of 
insurance  should  use  it,  because,  as  I  have  already 
pointed  out,  the  calculations  of  the  latter  are  not  pred- 
icated upon  the  investments  earning  a  definite  rate  of 
interest,  but  the  process  of  amortization  is  one  which 
should  be  used  by  every  corporation  which  intends  to 
hold  its  securities  for  investment  purposes;  in  no 
other  way  can  the  premium  on  the  bond  be  properly 
taken  into  account. 

An  unscientific  approximation  is  sometimes  made  by 
dividing  the  premium  on  the  bond  by  the  number  of 
periods  which  it  has  to  run  and  reducing  the  book 
value  by  the  resulting  quotient.  In  the  case  cited 
above,  for  instance,  the  premium  of  $44.91  would  be 
divided  by  10  and  $4.49  deducted  from  the  book  value 
every  six  months.  While  this  method  brings  the  book 
value  to  the  par  value  at  the  maturity  of  the  bond, 
it  does  not  properly  distribute  the  decreases  which 
should  take  into  account  the  interest  earnings  of  the 
sinking  fund. 

It  is  hardly  necessary  for  me  to  point  out  that  no 
method  of  amortization  can  be  applied  to  stocks  or  to 
bonds  which  have  no  definite  date  of  maturity,  for  the 
factors  which  are  necessary  in  order  that  we  may 
properly  amortize  are  as  follows: 


Examination  of  Insurance  Companies  79 

1.  A  definite  rate  of  interest  stated  in  the  bond. 

2.  A  definite  date  of  maturity. 

Having  these  two  and  the  purchase  price  we  are 
enabled  to  obtain  the  third  factor,  which  is 

The  effective  rate  of  interest, 
and  the  employment  of  these  three  as  in  the  preceding 
illustrations  will  enable  us  to  treat  securities  in  the 
scientific  manner  indicated. 

In  one  of  my  previous  talks  I  indicated  that  I  would 
again  refer  to  the  question  of  amortizing  bonds  which 
have  a  redemption  privilege  prior  to  the  date  of 
maturity.  If,  for  instance,  a  bond  maturing  in  thirty 
years  contain  a  provision  whereby  it  may  be  redeemed 
in  ten  years,  it  must  be  apparent  to  you  that  the 
holder  of  the  bond,  for  his  own  protection,  must  con- 
sider the  most  adverse  situation.  If  the  bond  has 
been  purchased  above  par,  therefore,  the  most  un- 
favorable situation  is  the  one  which  will  require  the 
entire  premium  to  be  provided  for  and  eliminated  at 
the  end  of  ten  years,  instead  of  at  the  end  of  thirty 
years,  when  the  bond  would  mature  if  the  privilege 
of  redemption  had  not  been  exercised. 

If  the  bond  has  been  purchased  below  par,  however, 
it  will  be  apparent  to  you  that  the  most  adverse  con- 
dition is  the  one  which  assumes  that  the  bond  will 
not  be  paid  off  until  its  date  of  maturity  and,  there- 
fore, that  the  accumulations  (the  difference  between 
the  purchase  price  and  the  par  value)  will  not  reach 
their  maximum  until  the  end  of  the  thirty  years. 


CHAPTER  X 

Liabilities  —  Net  Value  of  Life  Insurance  Policies  — 
Net  Terminal  Value  —  Mean  Reserve  —  Unearned 
Premiums  —  Unearned  Premiums  on  Marine  Pol- 
icies —  Perpetual  Policies  —  Reinsurance. 

In  my  previous  talks  I  have  briefly  referred  to  the 
various  items  of  assets  to  which  your  attention  will 
be  directed  in  your  examination  of  insurance  com- 
panies. In  order  to  arrive  at  its  surplus  it  must  be 
obvious  to  you  that  a  proper  consideration  should  be 
given  to  the  liabilities  with  which  the  company  should 
be  charged. 

Speaking  in  a  broad  sense,  I  should  consider  the  lia- 
bilities of  insurance  companies  under  four  groups,  viz. : 

1.  Policy  liabilities. 

2.  Claim  liabilities. 

3.  Dividend  liabilities. 

4.  Incidental  (all  other)  liabilities. 

In  the  first  group  I  place  those  liabilities  affecting 
active  policies  and  which  are  embraced  in  the  items  of 
''  net  value  "  of  life  insurance  companies  and  "  un- 
earned premiums  "  of  other  companies.  The  second 
group  will  comprise  the  liabilities  which  should  be 
maintained  to  provide  for  the  claims  and  losses  which 
have  occurred  prior  to  the  date  of  the  examina- 
tion, but  which  have  not  been  settled  in  full.  The 
third  group,  consisting  of  the  dividend  liabilities,  is 

[80] 


Examination  of  Insurance  Companies  81 

found  only  in  the  case  of  life  insurance  companies  and 
it  is  so  important  and  differs  so  radically  from  the 
miscellaneous  liabilities  of  insurance  companies,  that 
I  have  preferred  to  include  them  in  a  separate  group. 
The  incidental  liabilities  of  insurance  companies  are 
found  in  all  classes  of  insurance  companies  and  include 
the  unpaid  taxes,  unpaid  commissions,  unpaid  medical 
fees,  etc. 

In  the  case  of  companies  transacting  credit  insur- 
ance, there  is  a  special  liability  which  cannot  be 
referred  to  any  of  the  foregoing  subdivisions  and 
which  consists  of  50  per  cent,  of  the  gross  premiums 
on  the  credit  policies  which  expired  during  the  three 
months  preceding  the  date  of  the  examination.  The 
reason  for  the  inclusion  of  this  item  will  be  referred 
to  when  the  subject  of  credit  insurance  is  discussed 
more  at  length. 

The  net  value  of  life  insurance  policies  is  the  result 
of  an  accurate  mathematical  computation  which  takes 
into  account  not  only  that  portion  of  the  premium 
known  as  the  reserve,  but  includes  another  factor  — 
that  portion  of  the  premium  which  represents  the 
amount  which  will  have  to  be  paid  for  death  losses 
during  the  balance  of  the  policy  year  according  to  the 
table  of  mortality  upon  which  the  reserve  is  accumu- 
lated ;  it  is  this  factor  which  distinguishes  the  ' '  mean 
reserve  "  from  the  ''  net  terminal  value,"  for  it  is 
the  universal  practice  now  of  Insurance  Departments 
to  compute  mean  reserves  instead  of  interpolating  by 
months.  I  shall  dismiss  the  subject  of  the  reserves 
for  life  insurance  companies  with  these  few  remarks, 
for  it  is  a  phase  of  the  situation  which  is  so  closely 
allied  with  a  thorough  actuarial  training,  that  a  fur- 
6 


82  Examination  op  Insurance  Companies 

ther  discussion  would  be  out  of  place  in  a  general  talk 
such  as  this  is. 

The  method  of  computing  the  liabilities  on  the  pol- 
icies of  companies  transacting  other  than  a  life  insur- 
ance business,  is  so  entirely  different  from  the  policy 
reserve  just  referred  to,  that  I  might  have  been  justi- 
fied in  assigning  it  to  a  separate  group.  In  contradis- 
tinction to  life  insurance  reserves,  the  unearned  pre- 
mium account  is  not  scientifically  computed.  In  an 
address  which  I  delivered  some  years  ago  before  the 
National  Convention  of  Insurance  Commissioners,  I 
referred  to  the  '  ^  reserve  ' '  of  miscellaneous  companies 
as  follows: 

''  What  is  the  so-called  '  reserve?  '    Let  us  first 
consider  this  question  from  the  negative  view- 
point.   It  certainly  has  none  of  the  functions  of 
the  reserve  for  life  policies,  which  has  for  its 
purpose  the  accumulation  of  a  sufficient  amount  in 
the  early  years  of  a  contract  to  enable  the  de- 
ficiency of  subsequent  years  to  be  met  without  an 
undue  increase  in  rates.     It  is  not  intended  for 
the  reinsurance   of  a   company's   risks,  for  this 
contingency  is  to  a  certain  extent  a  remote  one, 
and,  therefore,  would  hardly  justify  a  provision 
of  this  kind.    It  does,  however,  occupy  the  same 
relation  to  a  corporation  which  the  governor  and 
flywheel  do  to  a  complicated  piece  of  machinery. 
As  a  steam  engine  would  run  wild  did  it  not  have 
some  controlling  mechanism,  so  would  a  corpora- 
tion indulge  in  equally  extravagant  operations  if 
some  check  were  not  placed  upon  it  so  that  it 
could  be  brought  face  to  face  with  a  realization 
that  all  of  the  premiums  written  by  it  are  not 
earned  the  moment  they  are  received,  but  a  por- 
tion of  them  must  be  set  aside  for  the  purpose 
of  meeting  losses   in  the  latter  history  of   the 
contract.'* 


Examination  of  Insurance  Companies  83 

The  unscientific  nature  of  the  computation  must  be 
apparent  to  you  when  you  stop  to  consider  that  when 
two  companies  have  issued  similar  policies  on  the  same 
risk  at  different  premium  rates,  the  amount  of  the 
unearned  premium  differs  in  each  case. 

The  States  have  differed  in  fixing  the  rate  at  which 
the  unearned  premiums  of  fire  and  miscellaneous  com- 
panies (the  term  ^'  miscellaneous  "  has  come  to  be 
applied  to  all  companies  which  do  not  transact  a  life, 
a  fire  or  a  marine  insurance  business)  shall  be  com- 
puted; some  require  that  50  per  cent,  of  the  gross  pre- 
mium shall  at  all  times  be  maintained;  others  require 
the  unearned  premiums  to  be  computed  upon  a  pro 
rata  basis. 

The  question  of  computing  the  pro  rata  basis,  there- 
fore, is  one  to  which  I  will  now  address  myself,  and  I 
may  mention  at  the  outset  that  there  are  two  methods 
of  doing  this;  the  more  exact  one,  whereby  each 
month's  business  is  treated  separately,  I  shall  first 
discuss. 

It  would  be  manifestly  impossible  to  take  each  pol- 
icy contract  and  compute  the  exact  number  of  days 
which  it  has  to  run  before  its  termination ;  it  has  been 
assumed,  therefore,  that  all  policies  are  issued  on  the 
fifteenth  of  the  month,  and  if  we  were  making  an 
examination  as  of  December  31,'' 1909,  for  instance,  and 
we  were  dealing  with  one-year  policies,  i.  e.,  policies 
that  are  to  run  for  twelve  months  from  the  date  when 
they  were  issued,  we  would  find  the  following  condi- 
tion of  affairs:  The  policies  which  were  issued  dur- 
ing December,  1909,  would  have  been  in  force  on  the 
average  for  fifteen  days,  or  half  a  month;  they  would 
have  earned,  therefore,  l/24th  of  the  premium  and  the 
Tineamed  portion  of  the  premium  with  which  they 


84  Examination  of  Insurance  Companies 

would  be  charged  would  be  23/24tlis;  policies  which 
were  issued  in  November,  1909,  have  been  in  force  one 
and  one-half  months,  and,  therefore,  the  unearned  por- 
tion of  the  premium  would  be  21/24ths;  in  the  same 
way  policies  issued  in  January,  1909,  would  have  only 
one-half  month  longer  to  run  before  their  termination, 
and  the  unearned  portion  of  the  premium  chargeable 
against  them,  therefore,  would  be  l/24th.  Bearing  in 
mind  that  the  date  of  the  examination  is  December  31, 
1909,  I  can  illustrate  by  the  following  table  the  frac- 
tions representing  the  unearned  portions  of  the  pre- 
miums on  a  two-year  policy,  i.  e.,  a  policy  which  had 
two  years  to  run  from  its  date  of  issue  and  which  was 
in  force  at  the  time  of  the  examination: 

Policy  issued  December,  1909,  for  24  months  has  47/48ths  unearned 
«  "      November,  1909,    "    24       "         "    45/48th3 

"      January,      1909,    "    24        "         "    25/48ths 
"  «      December,  1908,    "    24        «         "    23/48ths 

"      November,  1908,    "    24       «         "    21/48th3 

"      January,      1908,    "    24       «         «      l/48th 

I  have  not  used  the  intermediate  months,  but  they 
are  calculated  in  the  same  way;  applying  the  same 
method  to  a  three-year  policy  we  have  a 

Policy  issued  December,  1909,  for  36  months  has  71/72nd3  unearned 


"      November, 

1909, 

"    36 

u 

"    69/72nds 

"      January, 

1909, 

«    36 

a 

"    49/72nds 

"      December, 

1908, 

"    36 

(( 

"    47/72nds 

"      November, 

1908, 

"    36 

" 

"    45/72nds 

"      January, 

1908, 

"   36 

u 

"    25/72nds 

"      December, 

1907, 

"    36 

u 

"    23/72nds 

"      November, 

1907, 

"    36 

ii 

"    21/72nd8 

"      January, 

1907, 

"    36 

u 

"      l/72nd 

A  similar  method  will  be  followed  in  other  cases 
adjusted  for  the  term  of  the  policy  and  the  same  rule 
will  apply  to  examinations  made  as  of  dates  other  than 
December  31st,  it,  of  course,  being  necessary  in  these 
cases  to  make  the  proper  adjustment. 


Examination  of  Insurance  Companies  85 

The  other  pro  rata  method  which  is  more  generally 
used,  is  based  upon  the  assumption  that  the  pol- 
icies of  a  company  have  been  distributed  uniformly 
throughout  the  year.  In  other  words,  that  the  same 
number  of  policies  (or  rather  the  same  amount  of  pre- 
miums) have  been  written  in  January  as  in  February, 
March  and  the  other  months  of  the  year;  this  being 
so,  it  will  be  apparent  to  you  that  we  will  arrive  at 
correct  results  if  we  assume  that  every  policy  was 
issued  midway,  or  on  July  1st.  On  December  31,  1909, 
one-year  policies  will  upon  this  assumption  have  been 
in  force  six  months,  and  will  have  one-half  of  their 
term  complete,  the  unearned  premium  factor,  there- 
fore, being  %.  Two-year  policies  issued  during  1909 
have  been  in  force  on  the  average  six  months,  have 
eighteen  months  still  to  run  and  the  unearned  pre- 
mium factor  is,  therefore,  %.  The  application  of  this 
rule  results  in  obtaining  the  following  fractions  to 
represent  the  unearned  premium  factors,  and  in  order 
to  save  a  lengthy  description,  the  date  of  the  examina- 
tion is  again  assumed  to  be  December  31,  1909,  in 
each  case: 

Policies  issued  in  1909  for  1  year   have  1/2  of  gross  premium  unearned 

«  "       "  1908   "    2  years     "     1/4  "      " 

"  "       "  1909   "    2      "         "     3/4  " 

«  «       «  1907   "    3      "         "     1/6  " 

"  "       "  1908   "    3      "         "     1/2  " 

it  «       «  1909   «    3      «         «     5/6  « 

"  "       "  1906   "    4      "         "     1/8     " 

«  «       «  19Q7   «    4     «         «     3/8     « 

«  «       «  i9Qg   «   4      u         «     5/8     « 

«  «  "  1909  "  4  "  "  7/8  " 

«  "  "  1905  "  5  "  "  1/10  " 

"  «  "  1906  "  5  "  "  3/10  " 

a  «  «  1907  «  5  .<  «  1/2  « 

«     "   "  1908  "  5  "    "  7/10  " 
"  "       "   1909  "  5  "    "  9/10  " 

If  this  method  be  used  policies  mnning  for  less  than 
one  year,  but  still  in  force  at  the  time  of  the  examina- 


86  Examination  of  Insurance  Companies 

tion,  are  included  with  the  one-year  contracts,  50  per 
cent,  of  their  gross  premiums  being  carried. 

The  second  method  inferring  as  it  does  that  there 
is  a  uniform  distribution  of  the  company's  business 
throughout  the  months  of  the  year,  should  not  be  used 
in  those  cases  where  this  assumption  is  clearly  unjus- 
tified by  the  actual  facts  or  in  those  cases  where  the 
financial  condition  of  the  company  is  such  as  to  require 
an  absolute  determination  of  the  unearned  premium 
account. 

In  the  case  of  marine  insurance  companies,  there  is 
a  different  rule  for  calculating  the  unearned  pre- 
miums ;  on  policies  covering  hulls  and  what  are  known 
as  time  cargoes,  it  is  usual  to  consider  that  50  per  cent, 
of  the  outstanding  premiums  are  unearned.  On  car- 
goes insured  for  a  specific  voyage  (on  a  particular 
vessel  for  a  voyage  say  from  Liverpool  to  New  York) 
it  is  usual  to  require  that  100  per  cent,  of  the  gross 
premium  shall  be  carried  as  a  liability.  In  Massa- 
chusetts, for  instance,  this  has  become  part  of  sec- 
tion 11,  which,  in  stating  the  duties  of  the  commis- 
sioner, provides  that: 

^'  In  respect  to  marine  risks  he  shall  compute 
the  liability  thereon  by  charging  fifty  per  cent,  of 
the  amount  of  premiums  written  in  its  policies 
upon  yearly  risks,  and  upon  risks  covering  more 
than  one  passage  not  terminated,  and  the  full 
amount  of  premiums  written  in  policies  upon  all 
other  marine  risks  not  terminated ;  but  in  the  case 
of  foreign  fire  and  marine  insurance  companies 
with  less  than  three  hundred  thousand  dollars 
capital,  admitted  to  transact  fire  insurance  only 
in  this  commonwealth,  the  full  amount  of  pre- 
miums written  in  other  marine  and  inland  naviga- 
tion and  transportation  insurance  policies  shall 
^        be  charged  as  liability." 


Examination  of  Insurance  Companies  87 

The  only  other  special  form  of  unearned  premium, 
account  which  occurs  to  me  at  this  time  is  one  that 
you  may  find  in  the  examination  of  fire  insurance  com- 
panies located  in  the  State  of  Pennsylvania  and  the 
southern  part  of  New  Jersey;  these  companies  issue 
what  are  called  ''  perpetual  "  policies,  whereby  the 
owner  of  the  property  pays  a  sum  to  the  insurance 
company  when  the  policy  is  issued  and  no  further 
premiums  are  required,  the  assumption  being  that  the 
interest  on  the  deposit  will  be  sufficient  to  reimburse 
the  company  for  its  outlays  in  the  matter  of  losses. 
Should  the  policyholder  wish  to  surrender  his  policy 
he  is  entitled  to  receive  a  certain  percentage  (usually 
90  per  cent.)  of  the  deposit,  and  upon  these  contracts 
the  liability  charged  is  the  amount  of  the  premiums 
which  could  be  claimed  by  the  policyholders  if  they 
elected  to  cancel  their  policies. 

In  calculating  the  unearned  premiums  of  an  insur- 
ance company,  credit  should  be  given  for  the  reinsur- 
ance which  it  has  effected  in  other  solvent,'  admitted 
corporations.  The  credit  which  is  allowed  is  to  be 
calculated  in  the  same  way  in  which  the  unearned  pre- 
miums are  calculated.  In  the  case  of  life  insurance 
companies,  the  reinsurance  credit  is  the  reserve  which 
the  reinsuring  company  maintains  upon  the  policy 
which  it  issues  to  the  company  which  you  are  examin- 
ing. If,  for  instance,  the  compan.y  you  are  examining 
has  issued  an  endowment  policy  for  $100,000,  of  which 
it  has  reinsured  $50,000,  not  upon  the  endowment  plan 
but  as  a  one-year  term  policy,  you  would  charge  it 
with  the  reserve  on  the  $100,000  endowment  policy, 
and  give  it  credit  for  the  mean  reserve  on  the  term 
policy  which  has  been  issued  in  its  favor. 


88  Examination  of  Insueance  Companies 

I  pointed  out  to  you  that  the  method  of  computing 
the  policy  liability,  except  in  the  case  of  life  insurance 
companies,  was  unscientific,  and  you  will  appreciate 
this  the  more  if  you  stop  to  consider  that  although 
a  company  pays  its  commissions  and  all  other  expenses 
incident  to  the  procurement  of  its  business  when  the 
policy  first  goes  into  force,  the  unearned  premium 
account  is  nevertheless  calculated  upon  the  basis  of 
the  gross  premium. 


CHAPTER  XI 

Installment  Policies  —  Surrender  Values  Claimable  — 
Different  Forms  of  Death  Claim  Liabilities  —  Re- 
sisted Claims  —  Accident  and  Health  Claims  — 
Contingency  Reserve. 

The  second  group  of  liabilities  consists  of  the  claims 
and  losses.  The  claims  (I  have  used  this  term  to  dis- 
tinguish the  liability  from  a  death  loss  liability)  which 
you  will  find  in  your  examination  of  life  insurance 
companies  are  of  two  kinds,  those  arising  from  the 
unpaid  installments  on  death  claims  and  the  unpaid 
surrender  values  which  may  be  demanded  on  lapsed 
policies. 

Some  policies  provide  that  in  the  event  of  the  death 
of  the  insured  the  beneficiary  will  receive  the  amount 
insured  in  a  certain  number  of  stated  installments 
instead  of  in  one  lump  sum.  It  will  be  clear  to  you 
that  the  present  value  of  ten  installments  of  $100  each 
is  less  than  $1,000,  for  instance,  and  therefore  this 
method  of  payment  when  applied  to  any  form  of  insur- 
ance costs  less  than  does  the  payment  of  the  proceeds 
of  the  policy  in  one  sum.  Cheapness,  however,  is  not 
the  sole  consideration,  for  it  is  felt  by  many  policy- 
holders that  they  prefer  to  effectually  provide  for 
their  beneficiaries  receiving  a  definite  income,  rather 
than  to  trust  to  the  uncertainties  of  investments  which 
will  be  selected  by  the  beneficiaries  or  their  advisors. 

The  interest  rate  which  shall  be  used  in  determining 

[89] 


90 


Examination  of  Insurakcb  Companies 


the  present  value  of  the  instalhneiits  is  determined  by 
the  rates  specified  in  the  statutes  or  the  policies  for  the 
valuation;  if,  for  instance,  the  policies  are  valued 
according  to  some  mortality  table  with  interest  at  3^2 
per  centum  per  annum,  the  coromuted  value  of  the 
installments  would  be  calculated  at  that  rate.  Install- 
ment policies  provide  that  the  first  installment  shall 
become  due  and  payable  upon  the  approval  of  proofs 
of  death  and  the  others  upon  the  subsequent  anniver- 
saries of  the  death  of  the  insured.  In  the  case  of  a 
policy,  the  proceeds  of  which  are  payable  in  ten  install- 
ments, it  will  be  apparent  to  you  that 

The  1st  payment  is  due  immediately. 


''2nd 

'     "     in  1  year. 

''3rd 

"      "2  years 

"4th 

"      "  3      " 

"     5th 

"      "  4      " 

"6th 

"      "  5      " 

"7th 

"      "  6      " 

"8th 

"      "  7      " 

"9th 

"      "  8      " 

"  10th 

"      "  9      " 

From  this  table  you  will  see  that  all  of  the  values 
which  are  payable  will  have  been  paid  by  the  end  of 
the  ninth  year,  and  a  table  of  present  values  con- 
structed on  a  3 Mi  per  cent,  basis  for  a  $1,000  policy 
payable  in  ten  equal  annual  installments,  would  be  as 
follows : 


Present 

value 

of 

1st 

installment. . 

$100.00 

<< 

( ( 

a 

2nd 

<( 

96.62 

<( 

(( 

I  i 

3rd 

<  i 

93.35 

<( 

<  ( 

<< 

4th 

ii 

90.19 

n 

(< 

ii 

5th 

i( 

87.14 

Examination^  op  Insuraistce  Companies  91 

Present  value  of 


(I 


6th  installment . . 

$84  20 

7th 

81.35 

8th 

78.60 

9th 

75.94 

10th 

73.37 

$860.76 


In  other  words,  at  the  tune  of  the  death  of  the 
insured  the  present  value  of  the  liability  on  this  policy 
would  be  $860.76,  and  if  we  are  making  an  examina- 
tion as  of  December  31,  1909,  and  the  death  under  the 
foregoing  policy  had  occurred  on  July  1,  1909,  we 
would  charge  as  a  liability  the  present  value  of  $760.76 
due  in  six  months.  These  installment  payments  are 
sometimes  called  annuities  certain;  they  involve  no 
mortality  factor,  which  factor  is,  of  course,  taken  into 
account  in  any  real  annuity  contract,  as  the  term  is 
understood  in  life  insurance  phraseology. 

The  other  form  of  claims  arises  from  the  right  which 
a  policyholder  has  to  demand  a  surrender  value  within 
a  specified  time  upon  his  policy  contract  which  has 
lapsed  and  upon  which  the  company  is  no  longer  main- 
taining a  reserve.  If  the  legal  holder  have  the  right 
to  demand,  a  surrender  value  the  company  must,  of 
course,  be  prepared  to  meet  that  demand.  This  car- 
ries with  it  the  necessity  for  maintaining  as  a  liability 
the  amount  of  that  demand,  for  in  no  other  way  can 
we  reach  a  correct  determination  of  the  surplus  re- 
maining for  the  protection  of  all  the  policyholders. 
This  surrender  value  may  be  demanded  in  the  form  of 
a  cash  payment,  a  paid-up  policy  or  extended  insur- 
ance, the  form  not  affecting  the  amount  of  the  liability, 


92  Examination  of  Insurance  Companies 

for  in  the  case  of  paid-up  and  extended  values  we 
should  charge  as  a  liability  the  single  premium  neces- 
sary to  provide  for  the  protection. 

In  examining  any  insurance  company  it  is  important 
that  you  should  realize  that  a  liability  should  be  main- 
tained for  every  loss  or  claim  which  occurred  on  or 
before  the  date  of  the  examination,  even  if  the  com- 
pany has  not  been  made  aware  of  the  fact  until  some 
subsequent  date ;  in  arriving  at  a  statement  of  the  con- 
dition of  a  company,  you  are  concerned  not  with  the 
liabilities  of  whose  existence  the  company  was  aware, 
but  with  the  liabilities  which  existed,  and  you  should, 
therefore,  include  all  losses  which  were  outstanding  at 
the  time  of  your  examination ;  if,  for  instance,  a  policy- 
holder, living  in  Seattle  and  insured  in  a  life  insurance 
company  domiciled  m  New  York,  died  on  December  30, 
the  company  would  in  all  likelihood  receive  no  notice 
of  that  loss  until  some  time  in  January,  but  if  you 
were  making  an  examination,  that  loss  should  be  con- 
sidered as  a  liability  outstanding  on  December  31st. 
The  failure  of  the  company  to  maintain  this  liability 
is  not  a  legitimate  source  of  criticism  or  condemna- 
tion, but  many  well-managed  companies  to-day  are 
recognizing  the  correctness  of  this  view  and  are  main- 
taining a  reserve  necessary  to  provide  for  this  item 
and  based  upon  past  experience  or  actual  results. 

In  the  case  of  life  insurance  companies  the  liabilities 
on  account  of  death  claims  are  subdivided  by  the  an- 
nual statement  blank  into  a  number  of  items,  as 
follows : 

Losses  due  and  unpaid. 

Losses  in  process  of  adjustment  or  adjusted 
and  not  due. 


Examination  of  Insurance  Companies  93 

Losses  which  have  been  reported  and  no  proofs 
received. 

Matured  endowments  due  and  unpaid. 

Death  losses  and  other  policy  claims  resisted  by 
the  company. 

Due  and  unpaid  on  annuity  claims  involving  life 
contingencies. 

The  object  of  this  subdivision  is  to  enable  the  super- 
vising officer  to  observe  whether  the  company  is  set- 
tling its  losses  promptly  or  is  unduly  litigious  in  the 
treatment  of  its  policyholders.  If,  for  instance,  any 
unduly  large  amount  was  reported  as  unpaid  on  death 
losses  which  have  become  due,  the  supervising  officer 
would  be  justified  in  ascertaining  the  cause  for  this 
condition.  You  will  note  that  the  last  subdivision, 
* '  due  and  unpaid  on  annuity  claims  involving  life  con- 
tingencies,"  is  intended  to  provide  not  for  the  install- 
ment values,  but  for  the  annuity  contracts  of  the  com- 
pany ;  annuities  certain  involve  no  life  contingency,  for 
the  installments  are  payable  at  certain  definite  times 
either  to  the  beneficiary  or  to  some  other  recipient. 

With  the  exception  of  the  resisted  claims,  the  deter- 
mination of  the  amounts  due  in  the  other  subdivisions 
of  the  foregoing  classification,  is  a  simple  matter,  for 
they  will  be  the  amounts  due  under  the  policy  con- 
tracts; in  the  case  of  resisted  claims  we  are  required 
to  use  our  best  judgment  in  determining  what  the 
liability  should  be.  Life  insurance  companies  are 
unquestionably  subject  to  claims  which  have  no  justifi- 
cation, and  it  would,  therefore,  be  manifestly  unfair 
to  charge  as  a  liability  the  face  value  of  all  the  policies 
upon  which  actions  have  been  brought.  An  examina- 
tion of  the  loss  papers  will  soon  develop  whether  the 


94  Examination  of  Insurance  Companies 

company  is  disposed  to  refuse  payment  upon  claims 
which  it  should  recognize,  and  I  have  found  that  in  the 
case  of  honestly  conducted  companies  it  is  a  safe  and 
equitable  rule  to  charge  as  a  liability  one-half  of  the 
face  value  of  the  resisted  claims.  This  will  take  into 
account  not  only  the  judgments  which  the  company 
will  have  to  pay  on  cases  in  which  it  is  unsuccessful, 
but  also  the  costs  and  expenses  which  are  involved  in 
defending  claims  in  which  it  is  successful. 

In  the  case  of  companies  transacting  the  business  of 
accident  and  health  insurance,  there  are  different 
methods  employed  by  the  companies  for  the  mainte- 
nance of  the  loss  reserve  items.  It  is  the  usual  custom 
(and  I  think  one  which  may  be  characterized  as  safe 
and  sane)  to  divide  the  outstanding  losses  on  Decem- 
ber 31st  into  three  classes:  first,  the  specific  losses, 
i.  e.,  those  upon  which  the  company  has  received  notice 
that  a  death  has  occurred  or  an  insured  has  lost  a 
hand  or  a  foot,  upon  which  class  of  accidental  injuries 
the  policies  provide  for  a  definite  payment,  irre- 
spective of  the  ultimate  effects  of  the  injury. 

The  second  class  takes  into  account  other  serious 
injuries  and  includes  all  of  those  claims  which  give 
evidence  in  the  loss  notice  that  the  insured  will  be  dis- 
abled for  a  considerable  time.  The  third  class  em- 
braces the  non-serious  losses  or  those  upon  which  the 
approximate  period  of  disability  cannot  be  determined. 

The  proper  method  of  treating  the  second  and  the 
third  classes  is  based  upon  the  experience  of  the  com- 
pany; an  inspection  of  its  experience  for  five  or  ten 
years  (the  longer  the  period  of  observation  we  have, 
the  more  correct  will  be  our  estimates)  will  enable  us 
to  obtain  the  average  settlement  which  the  company 


Examination  of  Insueancb  Companies  95 

lias  made  on  its  serious  cases  and  a  corresponding 
figure  for  its  non-serious  cases.  The  application  of 
these  factors  to  the  number  of  cases  outstanding  at 
the  time  of  the  examination  will  form  a  basis  for  the 
liability  which  should  be  maintained;  the  methods  of 
settlement  may  vary,  the  increasing  liberality  in  policy 
contracts  which  competition  has  forced  the  various 
companies  to  adopt  and  the  varying  conditions  sur- 
rounding the  insured,  are  all  responsible  for  a  greater 
liability  than  has  been  maintained  by  insurance  com- 
panies in  the  past.  It  has  been  my  experience  that  the 
reserves  in  the  past  have  not  been  sufficient  to  meet  the 
losses,  but  I  wish  to  make  it  clear  that  this  has  arisen 
in  most  cases  from  no  intentional  desire  upon  the  part 
of  the  managers  to  understate  their  liabilities,  but 
from  an  honest  failure  to  appreciate  the  conditions 
which  I  have  just  mentioned  as  affecting  this  liability. 
Conservative  managers  are  beginning  to  realize  these 
changed  conditions  and  it  is  this  mental  attitude  which 
probably  accounts  for  the  item  which  you  will  find 
in  a  number  of  the  statements  of  well-managed  com- 
panies, viz.:  *'  contingency  reserve  "  or  **  voluntary 
reserve  "  sometimes  amounting  to  $50,000,  $100,000 
or  even  $250,000.  One  of  the  contingencies  which  the 
underwriters  have  in  mind  and  which  this  fund  is  sup- 
posed to  cover,  is  the  settlement  of  claims  at  higher 
figures  than  the  ones  at  which  they  have  been  carried 
in  the  annual  statement. 

I  hardly  deem  it  necessary  to  call  your  attention  to 
the  fact  that  in  any  statement  of  losses,  due  allowance 
must  be  made  for  reinsurance  in  solvent,  admitted 
companies,  but  care  must  be  exercised  lest  double  credit 
be   given,   first,   in   the   deduction   from   outstanding 


96  Examination  of  Insurance  Companies 

losses,   and  second,   as  the   allowance   of  the  claims 
against  reinsuring  companies  as  an  asset. 

It  is  likewise  important  in  the  case  of  every  com- 
pany to  ascertain  how  the  actual  settlements  under  its 
losses  have  compared  with  its  estimates.  It  requires 
some  time  for  losses  to  be  settled  and  it  is  advisable, 
therefore,  to  select  some  date  sufficiently  far  back  to 
indicate  the  effects  of  actual  settlements  of  the  losses. 
The  application  of  this  test  will  show  whether  the 
departments  charged  with  the  duty  of  furnishing  esti- 
mates of  the  outstanding  losses  have  appreciated  the 
true  import  of  the  notices  which  have  been  received. 


CHAPTER  XII 

Fire  Losses  —  Plate  Glass  Losses  —  Fidelity  and 
Surety  Policies  or  Bonds  Distinguished  —  Inability 
to  Keep  Track  of  Issues  —  Suggested  Remedies  — 
Salvage  —  Cosurety  —  Depository  Bonds. 

In  the  case  of  fire  insurance  companies  the  unpaid 
losses  are  divided  into  three  divisions  only:  those 
which  are  adjusted  and  due,  those  which  have  not  been 
adjusted  and  those  which  are  resisted.  From  the  ex- 
aminer's standpoint  the  treatment  accorded  losses  in 
fire  insurance  companies  is  characteristic  of  the 
methods  to  be  followed  in  the  examination  of  compa- 
nies transacting  the  other  forms  of  insurance,  with 
such  exceptions  as  I  shall  note  hereafter. 

In  companies  transacting  plate  glass  insurance,  the 
treatment  of  losses  is  peculiar,  inasmuch  as  the  way 
in  which  the  business  is  conducted  requires  that  losses 
shall  be  settled  not  only  promptly,  but  by  the  agency 
in  the  locality  in  which  the  loss  occurs.  It  would  never 
do,  for  instance,  for  a  Home  Ofl&ce  in  New  York  to 
attempt  to  arrange  for  the  replacement  of  a  broken 
pane  of  glass  in  Chicago.  Such  matters  of  adjustment 
are  usually  handled  by  the  agency  in  the  place  in  which 
the  loss  occurs  and  the  first  notice  that  the  Home 
Office  gets  of  a  loss  is  usually  accompanied  by  some 
evidence  of  its  settlement.  In  consequence  it  is  neces- 
sary to  take  this  fact  into  account  in  calculating  the 

[97] 

7 


98  Examination  of  Insurance  Companies 

liabilities  for  the  losses  in  plate  glass  insurance.  Inci- 
dentally I  may  call  your  attention  to  the  fact  that  this 
bears  upon  the  matter  to  which  I  called  your  attention 
yesterday,  viz. :  that  in  preparing  the  financial  state- 
ment of  a  company  we  should  charge  as  a  liability  the 
losses  which  had  occurred  at  the  date  of  the  examina- 
tion, whether  they  had  been  reported  to  the  Home 
Office  by  that  time  or  not. 

As  a  usual  thing  companies  which  transact  a  fidelity 
business  also  issue  surety  bonds,  and  it  may  be  well 
for  me  to  define  these  two  classes  of  business.  A 
fidelity  policy  is  a  contract  entered  into  between  an 
insurance  company  and  an  obligee,  whereby  the  former 
guarantees  the  faithful  performance  of  a  duty  by  some 
third  party;  it  does  not  require  that  the  third  party 
shall  even  be  aware  of  the  existence  of  the  policy.  The 
forms  used  for  this  contract  are  those  prepared  by  the 
company  and  are  not  fixed  by  statute. 

It  is  the  practice  of  fidelity  and  surety  companies 
to  classify  only  the  foregoing  as  ''  fidelity  "  risks,  all 
other  forms  being  considered  as  "  surety;"  the  latter 
classification  includes  appeal  bonds  (given  to  protect 
litigants  in  appeal  cases)  —  guardians',  referees'  and 
administrators'  bonds  (forms  of  guarantee  usually 
required  by  the  courts)  — contractors'  bonds,  guaran- 
teeing that  they  will  complete  their  work  in  accordance 
with  specifications  —  maintenance  bonds,  given  to  a 
city,  for  instance,  to  guarantee  that  the  asphalt  streets 
will  be  maintained  in  a  proper  condition  for  a  certain 
number  of  years  —  excise  bonds,  providing  for  a  pen- 
alty in  the  event  of  the  violation  of  the  statutes  by  a 
liquor  dealer  —  supply  bonds,  covering  the  quality  of 
supplies  to  be  furnished,  and  the  various  other  forms 


Examination  of  Insurance  Companies  99 

for  which  modern  civilization  has  created  a  demand. 
Broadly  speaking  a  fidelity  policy  may  be  said  to 
involve  the  integrity  of  some  person  who  is  to  perform 
a  duty,  while  in  surety  bonds  this  element  is  absent. 
It  must  not  be  understood  that  this  distinction  is 
inflexible,  for  it  will  be  apparent  to  you  that  some  of 
the  bonds  which  I  have  just  characterized  as  ' '  surety  ' ' 
do  involve  the  element  of  integrity  to  a  certain  extent. 

There  is  one  matter,  however,  to  which  I  wish  to 
draw  your  attention  in  the  treatment  of  fidelity  poli- 
cies or  bonds;  it  is  the  usual  practice  of  companies 
issuing  them  to  provide  that  the  obligee  shall  have  a 
certain  time  after  the  expiration  of  the  bond  in  which 
to  discover  evidences  of  peculation  or  wrongdoing.  If, 
for  instance,  a  fidelity  policy  has  been  issued  to  an 
employer  guaranteeing  the  honesty  of  his  employee 
for  twelve  months  from  January  1,  1909,  it  is  usual  to 
include  in  the  policy  form  a  provision  that  the  em- 
ployer has  until  July  1,  1910,  in  which  to  report  any 
dishonest  acts  which  were  committed  during  the  twelve 
months  from  January  1,  1909.  You  will  of  course 
recognize  the  justice  of  this  privilege.  For  that 
reason  I  have  raised  the  point  (and  I  think  the  correct- 
ness of  it  is  now  generally  admitted)  that  it  is  incor- 
rect for  a  company  to  consider  that  the  bond  which  I 
have  just  mentioned  expired  on  January  1,  1910. 
Some  provision  should  be  made  for  the  losses  which 
may  be  reported  to  the  company  during  what  I  may 
term  the  ' '  period  of  discovery, ' '  viz. :  the  six  months 
which  have  elapsed  since  the  bond  or  policy  ter- 
minated. 

In  the  case  of  fidelity  and  surety  bonds  (and  you 
will  note  throughout  this  talk  that  I  have  used  the 


100        Examination  of  Insurance  Companies 

terms  "  policies  "  and  '*  bonds  "  interchangeably) 
there  are  numerous  points  to  which  I  wish  to  direct 
your  attention.  In  the  first  place,  I  wish  to  point  out 
the  dangerous  situation  which  is  prevalent  at  the  pres- 
ent time  owing  to  the  way  in  which  the  bonds  are 
issued.  In  a  subsequent  talk  I  shall  refer  to  the  proper 
way  of  ascertaining  whether  the  agents  of  other  mis- 
cellaneous companies  who  have  the  privilege  of  issuing 
policies  from  their  own  offices  are  reporting  the  issues 
to  the  Home  Office.  That  method  of  checking,  how- 
ever, will  not  be  applicable  to  fidelity  and  surety  com- 
panies, for  the  nature  of  the  business  prevents  the  use 
of  printed  and  numbered  forms  furnished  from  the 
Home  Office.  The  language  employed  in  bonds  is  dis- 
similar and  has  to  be  adapted  to  each  particular  case, 
so  the  use  of  a  printed  form  is  practically  an  impossi- 
bility. I  have,  therefore,  suggested  that  the  remedy 
for  this  condition  might  be  found  in  one  of  three  ways, 
and  I  wish  to  refer  to  them  here  in  order  that  j^ou  will 
have  them  in  mind. 

I  suggested  first  that  the  various  Legislatures  or  the 
Insurance  Commissioners  (if  they  have  the  power) 
shall  require  that  all  court  bonds  be  either  executed  on 
printed  forms  furnished  by  the  Home  Office  and 
authenticated  by  the  proper  officers,  or  that  they  be 
written  upon  sheets  of  paper  furnished  by  the  Home 
Office  and  registered  there  in  some  way.  The  second 
remedy  that  I  proposed  was  that  all  bonds,  such  as 
maintenance  and  general  surety,  be  written  only  upon 
sheets  of  paper  furnished  by  the  Home  Office  and  re- 
corded as  previously  suggested.  In  lieu  of  the  fore- 
going I  suggested  that  statutes  should  be  enacted  in 
the  various  states  requiring  that  every  bond  issued  by 


Examination  op  Insueance  Companies        101 

any  agent  shall  have  attached  to  it  a  certificate  from 
the  Insurance  Commissioner  of  the  State  where  the 
agency  is  located  certifying  to  the  fact  that  the  com- 
pany is  authorized  to  transact  business.  If  this  were 
done  the  company  could  have  a  complete  record  of  the 
certificates  which  Jiave  been  used  by  any  agency  and 
it  would  be  a  simple  matter  to  verify  the  data  of  the 
bonds  to  which  the  certificates  have  been  attached.  At 
the  present  time  to  properly  check  the  court  bonds,  for 
instance,  which  have  been  issued,  an  auditor  from  the 
Home  Office  is  compelled  to  visit  every  court,  examine 
the  records  and  ascertain  the  bonds  upon  which  his 
company  is  bound. 

The  question  of  salvage  has  more  bearing  upon 
surety  matters  than  upon  almost  any  other  form  of 
indemnity,  although  in  the  case  of  fire  insurance  com- 
panies and  marine  companies  we  find  that  salvage 
items  exist ;  we  do  not  find  them,  however,  to  the  same 
extent  as  we  do  in  surety  companies.  At  the  present 
time  companies  are  not  permitted  to  take  credit  for 
salvage  (doubtless  owing  to  the  peculiar  nature  of  the 
various  items  which  are  claimed)  and  it  would  be  a 
matter  of  some  difficulty  to  lay  down  any  rule  for  the 
proper  allowance  of  salvage  as  an  asset.  At  the  same 
time  we  must  not  close  our  eyes  to  the  fact  that  equity 
requires  us  to  admit  that  salvage  has  some  value,  and 
while  in  the  case  of  a  company  with  a  substantial  sur- 
plus the  question  of  salvage  is  unimportant,  the  sub- 
ject has  considerable  weight  and  importance  in  the 
case  of  a  smaller  company  not  possessed  of  a  large 
working  surplus;  in  the  former  case  it  is  the  usual 
practice  to  disregard  the  salvage  and  simply  consider 
it  as  so  much  profit  when  it  is  disposed  of. 


102        Examination  of  Insurance  Companies 

Co-surety  is  a  term  applied  to  an  agreement  whereby- 
one  surety  company  agrees  to  become  liable  on  any 
particular  risk  with  another.  For  instance,  in  some 
court  proceedings  two  sureties  are  required,  no  matter 
how  strong  financially  one  of  them  may  be;  in  conse- 
quence it  is  the  usual  practice  for  a  surety  company 
to  become  co-surety  with  another  in  consideration  of 
an  almost  insignificant  premium.  I  have  in  mind  one 
case  where  on  a  bond  of  $200,000  Company  A  received 
only  l/42d  of  the  premium  which  Company  B  received, 
and  the  latter  executed  an  agreement  whereby  Com- 
pany A  was  to  become  liable  for  only  l/42nd  of  the 
losses.  While  this  agreement  may  have  been  binding 
upon  the  two  companies,  it  did  not  affect  the  court  or 
the  person  to  whom  the  bond  was  given,  as  Company 
A  was  liable  for  the  full  amount  of  the  bond,  $200,000, 
if  for  any  reason  Company  B  could  not  have  met  the 
liability. 

Depository  bonds  are  bonds  issued  by  surety  com- 
panies guaranteeing  that  a  deposit  in  a  bank  or  a  trust 
company  will  be  paid  upon  demand.  It  is  the  usual 
custom  for  municipal  bodies  (a  State  or  a  city)  to 
require  that  a  bank  in  which  their  funds  are  deposited 
shall  furnish  a  depository  bond.  In  times  of  financial 
stress  and  panic  these  bonds  may  become  a  serious 
menace  to  the  surety  companies  issuing  them.  While 
the  percentage  of  losses  which  the  depositors  of  banks 
in  this  country  have  sustained  is  commendably  small, 
and  therefore  the  question  of  ultimate  loss  may  not  be 
a  vital  one,  a  surety  company  may  be  seriously  embar- 
rassed by  the  necessity  of  paying  out  large  sums  of 
money  at  one  time  and  being  compelled  to  wait  until 
the  liquidation  of  various  banking  institutions  pro- 


Examination"  of  Insurance  Companies        103 

vides  funds  for  repayment.  The  law  of  average  does 
not  work  here  as  in  the  case  of  other  forms  of  insur- 
ance, for  it  must  be  apparent  to  you  that  there  will  be 
an  uneven  distribution  of  losses ;  panicky  times  affect 
all  of  the  depositories  upon  which  a  company  has 
issued  its  bonds,  while  in  the  case  of  other  forms  of 
indemnity,  sources  of  losses  do  not  affect  all  of  the 
policyholders  at  the  same  time. 


CHAPTER  XIII 

Special  Liabilities  —  Credit  Policies  —  Definition  — 
Methods  of  Treating  Accounts  with  Insolvent 
Debtors  —  Liability  Policies  Distinguished  from 
Workmen's  Collective  Policies  —  New  York  and 
Michigan  Methods  of  Computing  Reserves. 

If  we  examine  the  schedule  of  liabilities  in  the 
annual  statement  blank  which  miscellaneous  insurance 
companies  are  required  to  file  with  the  various  Insur- 
ance Departments,  we  find  that  there  are  two  kinds  of 
business  for  which  special  items  are  provided  —  credit 
insurance  and  liability  insurance.* 

The  special  items  applicable  to  credit  insurance  are 
of  two  kinds,  one  being  "  special  reserve  for  accrued 
losses  on  policies  expiring  in  October,  November  and 
December,"  the  other  being  ^'  special  reserve  for 
accrued  losses  on  credit  policies  in  force."  In  order 
that  these  special  items  may  be  thoroughly  understood, 
it  will  be  necessary  for  me  to  explain  the  theory  upon 
which  credit  insurance  is  founded. 

A  credit  insurance  policy  may  briefly  be  described 
as  an  agreement  upon  the  part  of  an  insurance  com- 
pany to  indemnify  its  policyholder  against  losses 
arising  from  the  insolvency  of  his  customers  in  excess 
of  Ms  average  experience;  you  will  note,  therefore, 
that  he  is  not  protected  against  all  of  the  losses  which 

*  See  chapter  XXI. 

[104] 


Examination  of  Insurance  Companies        105 

he  may  sustain,  but  only  against  those  which  are  in 
excess  of  his  usual  experience.  This  average  experi- 
ence or  ''  initial  loss  "  or  "  own  loss  "  (these  being 
the  terms  usually  applied)  is  found  by  taking  an  aver- 
age of  the  losses  which  the  merchant  has  sustained 
from  the  insolvency  of  his  customers  during  the  pre- 
ceding five  years.  You  will  find  that  the  policy  re- 
quires that  the  insured  shall  protect  himself  and  the 
company  against  abnormal  bad  debts  by  selling  only 
a  limited  amount  of  merchandise  to  those  customers 
who  are  not  financially  strong,  the  amount  of  the  sales 
which  the  merchant  is  permitted  to  make  being  based 
upon  the  rating  given  the  customer  by  the  recognized 
commercial  agencies ;  you  will  also  find  that  the  policy 
provides  that  the  company  shall  not  be  liable  for  more 
than  a  certain  amount  on  any  one  risk  (irrespective  of 
the  rating) ,  and  that  its  total  liability  under  the  policy 
is  limited  to  a  certain  figure.  For  instance,  the  policy 
may  be  what  is  called  a  $25,000-$100,000  policy,  which 
means  that  after  the  initial  loss  has  been  sustained  by 
the  insured,  the  maximum  amount  for  which  the  com- 
pany is  liable  on  any  one  of  the  merchant's  customers 
is  $25,000,  and  the  maximum  amount  for  which  the 
company  is  liable  on  any  number  of  insolvent  cus- 
tomers is  $100,000. 

I  know  of  no  other  form  of  insurance  which  is  like 
credit  insurance  in  the  particular  which  I  am  now 
about  to  describe,  viz.,  that  no  loss  can  be  collected  by 
the  assured  under  a  credit  policy  until  it  has  expired. 
The  policy  provides  that  the  protection  shall  cover  a 
certain  period,  in  nearly  every  case  a  year ;  at  the  ex- 
piration of  that  period  an  accounting  is  made  between 
the  assured  and  the  company,  and  if  the  initial  loss, 


106        Examination  of  Insurance  Companies 

has  been  exceeded,  then  the  company  is  liable  for  the 
excess.  While  the  assured  has  to  give  the  company 
notice  of  every  loss  as  soon  as  it  occurs,  no  settlement 
or  adjustment  can  be  made  until  the  policy  has  ex- 
pired. The  assured  has  thirty  days  after  the  expira- 
tion to  file  his  claim  with  the  company,  and  the  com- 
pany has  sixty  days  after  that  to  investigate  the 
accounts  and  make  its  settlements  with  the  policy- 
holder. 

Under  these  circumstances  you  will  see  the  wisdom 
of  requiring  that  a  company  shall  carry  as  a  liability 
the  unearned  premium  on  the  policies  expiring  in  the 
three  months  preceding  the  date  of  the  examination, 
less,  however,  any  amount  which  has  been  paid  to  the 
assured  on  account  of  those  policies.  If,  for  instance, 
a  policy  expired  in  October,  and  the  company  were 
able  to  adjust  the  account  in  November,  it  would  be 
manifestly  unfair  to  the  company  to  give  it  no  credit 
on  December  31st  in  this  item  for  the  payment  which 
it  had  made. 

Credit  companies  have  different  methods  of  treating 
the  accounts  with  insolvent  debtors  which  remain 
open  at  the  time  of  the  settlement.  A  credit  company 
may  take  an  assignment  of  the  claim  of  its  assured 
in  such  accounts  and  rely  for  its  repayment  upon  the 
settlement  which  the  insolvent  debtor  makes  with  his 
creditors.  In  other  cases  the  assured  may  be  willing 
to  allow  a  claim  against  one  of  his  customers  at  a 
figure  satisfactory  to  the  company,  and  the  company 
then  is  required  to  pay  only  the  difference  between  the 
amount  owed  and  the  figure  at  which  the  account  is 
taken  over.  A  third  method  is  by  the  making  of  an 
agreement   between    the    company    and    the    assured 


Examination  of  Insurance  Companies        107 

whereby  in  the  case  of  doubtful  accounts  the  matter  is 
permitted  to  remain  open,  the  company  assuming  its 
liability  for  settlement  to  be  made  in  the  future.  In 
some  cases  which  have  come  to  my  attention  recently 
it  has  been  the  practice  of  companies  to  disregard  such 
agreements  in  a  statement  of  their  liabilities  and  to 
consider  that  the  loss  has  been  adjusted  and  the  inci- 
dent closed.  It  will  be  apparent  to  you  that  this 
method  of  treatment  is  incorrect,  for  some  liability 
does  exist  on  account  of  these  unadjusted  items. 

I  pointed  out  to  you  in  my  first  talk  that  supervision 
in  this  country  was  largely  a  matter  of  gradual  devel- 
opment, and  this  method  of  charging  a  liability  for 
the  expirations  of  the  three  months  preceding  the 
examination  is  an  instance,  for  this  requirement  was 
not  enforced  until  about  seven  years  ago,  when  the 
first  real  examination  of  a  credit  insurance  company 
in  this  country  was  made.  Until  that  time  only  50 
per  cent,  of  the  gross  premiums  were  charged  as  a 
liability,  the  item  being  treated  in  exactly  the  same 
way  as  the  unearned  premium  account  of  a  fire  or  an 
accident  company  was.  During  that  examination  it 
developed  that  some  provision  ought  to  be  made  for 
the  policies  expiring  in  the  preceding  three  months. 

That  method  was  followed  until  1909,  when  the  New 
York  and  the  Massachusetts  Insurance  Departments 
made  an  examination  of  a  credit  insurance  company 
and  developed  the  fact  that  the  charging  of  50  per 
cent,  of  the  gross  premiums  was  not  a  sufficient  allow- 
ance, for  the  reason  which  I  have  indicated,  viz.,  that 
owing  to  the  peculiar  nature  of  credit  insurance,  none 
of  the  losses  could  be  paid  until  the  expiration  of  the 
policy,  and,  therefore,  none  of  the  premiums  could  be 


108        Examination  of  Insurance  Companies 

earned  until  that  time.  These  two  Departments,  there- 
fore, established  the  rule  that  on  all  unexpired  policies 
75  per  cent,  of  the  gross  premiums  written  should  be 
carried  as  a  liability  instead  of  50  per  cent,  as  hereto- 
fore. This  extra  25  jDer  cent,  is  the  amount  to  be  car- 
ried in  the  ''  special  reserve  for  accrued  losses  on 
credit  policies  in  force  ' '  mentioned  before,  the  remain- 
ing 50  per  cent,  being  included  in  the  calculation  of 
the  unearned  premiums.  I  think  the  reasoning  is 
eminently  sound  and  it  is  in  line  with  the  idea  which 
I  had  in  mind  as  expressed  in  the  paper  which  I  read 
before  the  National  Convention  of  Insurance  Commis- 
sioners in  September,  1907,  in  outlining  what,  in  my 
opinion,  should  be  considered  the  proper  reserve  on 
surety  bonds: 

* '  I  believe  then  that  no  surety  company  should 
consider  a  premium  or  fee  earned  until  all  possi- 
bility of  risk  thereon  has  passed  away.  To  give 
this  idea  concrete  form  I  would  say,  that,  in  my 
opinion,  a  company  should  carry  as  an  unearned 
premium  charge  the  gross  premiums  which  it  has 
received  upon  risks  still  open,  less  any  payments 
which  have  been  made  to  agents,  or  brokers,  for 
securing  the  business.  I  am  willing  to  admit  what 
must  be  apparent  to  all  who  have  considered  this 
problem,  viz.,  that  this  proposition  will  be  in- 
effectual unless  a  sufficient  premium  or  fee  be 
charged.  This  criticism  must  apply  to  any  lia- 
bility charge  based  upon  the  premium  received, 
and  without  this  adequacy  it  will  be  impossible  to 
prevent  the  inequality  between  companies  which 
I  pointed  out  in  a  previous  paragraph. ' ' 

The  two  departments  just  referred  to,  have  assumed 
that  the  procurement  expenses  (the  agency  expenses) 


Examination  of  Insueance  Companies        109 

will  amount  to  25  per  cent,  of  the  gross  premiums, 
hence  they  have  charged  the  balance,  75  per  cent.,  as 
the  representation  of  the  unearned  premium;  whether 
this  amount  is  correct  or  not  depends  largely  upon  the 
business  conditions  of  the  country.  In  times  of  great 
prosperity  the  losses  of  a  credit  company  will  never 
equal  that  figure,  and  I  think  the  reverse  is  true,  viz.: 
that  in  times  of  depressed  business  conditions  it  is  not 
unlikely  that  the  figure  will  be  exceeded. 

The  table  to  which  I  referred  the  other  day  as  com- 
paring the  actual  settlements  with  the  estimates,  is 
particularly  useful  in  the  matter  of  credit  insurance, 
for  it  shows  the  adequacy  of  the  estimates  which  have 
been  made  in  the  past.  It  is  well  not  to  lose  sight  of 
the  general  practice  of  Insurance  Departments  in  this 
matter  and  the  theory  upon  which  the  liabilities  for 
annual  statement  purposes  are  prepared.  It  is  assumed 
that  companies  will  provide  for  the  most  adverse  con- 
dition of  affairs  and  that  the  liabilities  which  they  will 
carry  will  be  sufficient  to  meet  such  conditions.  Should 
it  become  necessary  for  a  credit  company  to  reinsure 
its  business  it  is  not  unlikely  that  the  company  which 
takes  over  its  policies  would  require  its  unearned  pre- 
mium account  to  be  computed  on  the  basis  of  75  per 
cent,  of  the  written  premiums,  and  the  requirement  of 
the  Departments,  therefore,  is  justified. 

In  order  that  you  may  understand  the  special  item 
referring  to  liability  companies  "  special  reserve  for 
unpaid  liability  losses  "  it  will  be  necessary  for  me  to 
make  a  more  extended  explanation.  You  will  recall 
that  a  liability  policy  is  an  agreement  made  by  an  in- 
surance company  to  indemnify  the  assured  against  loss 
from  the  liability  imposed  hy  law  upon  the  assured  for 


110        Examination  of  Insurance  Companies 

damages  which  are  the  result  of  bodily  injuries  (both 
fatal  and  non-fatal)  which  are  suffered  by  certain  other 
person  or  persons.  There  are  various  forms  of  liabil- 
ity policies ;  employers '  liability,  covering  the  accidents 
to  employees  —  elevator  liability,  covering  the  liabili- 
ties resulting  from  accidents  due  to  elevators  —  teams* 
liability,  covering  accidents  caused  by  teams  —  physi- 
cians'  liability,  protecting  the  assured  against  claims 
of  malpractice,  error  or  mistake,  and  various  other 
forms. 

A  distinction  must  be  drawn  between  a  liability 
policy  and  a  workmen's  collective  policy,  for  under  the 
former  the  company  is  not  liable  for  any  indemnity  or 
any  payments  made  by  the  assured  for  ivhich  he  cannot 
be  legally  held  responsible.  If,  for  instance,  a  work- 
man should  be  injured  and  the  injury  be  not  the  result 
of  negligence  upon  the  part  of  the  employer,  or  be  one 
for  which  he  (the  employer)  is  not  legally  liable,  there 
could  be  no  recovery  under  the  liability  policy,  even 
if  the  employer  should  wish  to  pay  the  injured  work- 
man his  wages  during  the  time  of  his  disablement. 
Under  a  workmen's  collective  policy,  however,  the 
contingency  which  I  have  just  mentioned  would  be 
covered. 

The  difficulty  in  estimating  the  future  losses  under 
liability  policies  arises  from  two  causes.  Different 
companies  have  different  methods  of  handling  their 
losses;  one  may  feel  that  it  is  its  duty  to  contest  every 
claim  which  is  made  against  one  of  its  policyholders, 
and,  therefore,  its  losses  will  not  be  settled  for  a  great 
many  years ;  another  company  may  feel  that  the  proper 
method  of  handling  its  losses  is  to  make  prompt  set- 
tlements.   The  second  cause  is  the  more  serious  and 


Examination  of  Insurance  Companies        1.11 

important  one,  viz.:  that  the  relation  between  the  em- 
ployer and  the  employee,  which  is  the  basis  upon 
which  liability  insurance  is  predicated,  is  changing 
day  by  day.  The  limits  of  the  liability  incurred  by  the 
employer  are  being  broadened  and  widened  in  such  a 
way  as  to  make  it  more  difficult  for  the  employer  to 
escape  the  results  of  any  accident.  In  fact,  there  seems 
to  be  a  tendency  to  compel  the  employer  to  figure  the 
wear  and  tear  on  his  employees  in  the  same  way  that 
he  does  the  wear  and  tear  on  his  machinery,  and  to 
figure  that  the  cost  of  accidents  occurring  during  the 
manufacture  of  any  article  should  be  included  among 
the  legitimate  costs  of  production.  It  would  appear 
that  we  are  rapidly  approaching  a  Workmen's  Com- 
pensation Act  in  this  country  similar  to  the  one  in 
vogue  in  some  of  the  European  countries,*  whereby 
the  workman  receives  compensation  for  injuries  sus- 
tained during  the  course  of  his  work,  whether  they  be 
caused  by  his  negligence  or  not  (intentional  injuries  or 
the  wilful  disregard  of  safety  devices,  being  the  only 
bars  to  recovery).  In  Germany  this  feature  of  work- 
men's compensation  has  probably  received  more  at- 
tention than  in  any  other  country.  In  England  the 
changes  have  served  rather  to  modify  the  relationship 
between  the  employer  and  the  employee  rather  than  to 
place  the  indemnity  upon  the  basis  of  a  compensation 
act;  it  would  appear,  however,  that  these  modifications 
in  England  have  not  resulted  in  the  satisfactory  con- 
dition hoped  for  by  their  sponsors. 

All  of  the  aforementioned  reasons  made  it  necessary 
to  devise  some  method  of  arriving  at  a  proper  reserve 

*  The   State    of    New    York   now   has   one   which    applies    to    eight 
hazardous  occupations. 


112        Examination  of  Insueance  Companies 

for  future  settlement  of  losses  which  had  accrued  on 
liability  policies.  In  New  York  the  rule  for  the  calcu- 
lation of  this  particular  liability  is  found  in  section  86 
(see  Appendix  J) ;  this  method  provides  for  the  di- 
vision of  the  data  for  the  loss  reserve  into  two  parts: 
first,  the  ascertainment  of  the  number  of  notices  of 
injury  which  have  been  received  within  eighteen 
months,  and  second,  the  number  of  suits  outstanding 
upon  notices  received  more  than  eighteen  months  be- 
fore the  time  of  rendering  the  report.  In  the  case  of 
companies  which  have  been  in  the  business  for  ten 
years  or  longer,  the  experience  of  each  company  is 
examined  in  order  to  find  out  what  is  the  average 
amount  which  it  has  paid  on  its  suits  and  also  what 
amount  it  has  paid  on  notices  which  were  settled  with- 
out litigation.  These  factors  having  been  determined, 
they  are  multiplied  by  the  number  of  each  of  the 
appropriate  items,  and  from  the  product  is  deducted 
the  amount  of  all  payments  which  it  has  made  on  ac- 
count of  the  injuries  reported  within  eighteen  months. 
It  is  difficult  in  a  few  words  to  properly  express  all 
of  the  terms  of  this  law,  and  you  are  referred  to  the 
statute  itself  in  order  that  you  may  learn  all  of  its 
provisions. 

In  Michigan,  the  law  is  based  upon  a  different 
theory.  The  number  of  notices  and  suits  is  disregarded 
and  the  company  is  required  to  carry  as  a  liability 
50  per  cent,  of  the  premiums  received  and  earned, 
which  result  is  adjusted  by  such  an  amount  as  in  the 
opinion  of  the  Insurance  Commissioner  is  necessary 
(see  Appendix  K). 

It  is  the  consensus  of  opinion  that  neither  of  these 
laws  gives  satisfactory  results,  and  at  the  present  time 


Examination  of  Insurance  Companies        113 

(November,  1910),  the  subject  is  receiving  the  careful 
attention  of  liability  underwriters;  it  seems  desirable 
from  many  standpoints  to  base  the  estimate  of  future 
losses  upon  the  experience  of  the  past,  both  as  to  the 
amount  of  payments  and  the  length  of  time  which  will 
elapse  between  the  date  of  loss  and  the  date  of  pay- 
ment. In  connection  with  this  I  wish  you  to  read  an 
article  on  this  subject  which  appeared  in  the  *'  Weekly 
Underwriter  "  in  February,  1908,  and  of  which  you 
have  received  copies  (see  Appendix  L).  I  also  wish 
to  direct  your  attention  to  a  paper  which  I  read  before 
The  Liability  Association  in  October,  1910  (see  Ap- 
pendix Q),  outlining  a  different  method  for  arriving  at 
the  loss  reserve.  In  California,  Connecticut,  Illinois 
and  Massachusetts  the  statutes  governing  the  calcula- 
tion of  the  loss  reserve  item  are  practically  the  same 
as  the  one  on  the  statute  books  in  New  York. 

Before  concluding  this  talk  on  the  subject  of  lia- 
bility and  credit  insurance,  I  desire  to  briefly  refer  to 
the  question  of  the  "  limits  of  risk."  Under  a  liability 
policy  the  limitations  are  usually  expressed  in  a  simi- 
lar manner  to  the  method  outlined  for  credit  insurance ; 
a  policy  issued  on  a  $5,000-$100,000  basis  would  mean 
that  while  on  any  particular  accident  the  company's 
liability  is  limited  to  $100,000  on  all  persons,  it  does 
not  hold  itself  responsible  for  more  than  $5,000  on  any 
one  life.  The  limit  on  this  policy  would  be  $100,000. 
In  the  case  of  a  credit  insurance  policy,  however,  a 
vital  distinction  exists,  and  the  limit  is  considered  to 
be  the  amount  which  the  company  will  be  required  to 
pay  upon  the  insolvency  of  any  one  debtor;  in  the  illus- 
tration before  mentioned,  a  $25,000-$100,000  policy, 
the  limit  would  be  $25,000. 
8 


114        Examination  of  Insurance  Companies 

There  is  another  distinction  to  which  your  attention 
should  be  directed  between  these  two  forms;  under  a 
credit  policy  the  company  can  never  be  compelled  to 
pay  out  more  than  the  maximum  limit,  while  under  a 
liability  policy  the  maximum  limit  as  stated  applies 
only  to  one  accident,  and  the  liability  of  the  company, 
therefore,  continues  upon  subsequent  occurrences. 


CHAPTER  XIV 

Miscellaneous  Liabilities  —  Special  or  Advisory  Board 
Contracts  —  Taxes  Due  or  Accrued  —  Borrowed 
Money  —  Capital  Stock  —  Sale  of  Stock  in  Connec- 
tion with  Life  Insurance  Forbidden. 

Before  taking  up  the  question  of  the  liabilities  re- 
sulting from  the  dividends  on  life  insurance  policies, 
I  shall  refer  to  the  miscellaneous  liabilities  which  are 
found  in  the  statement  of  life  insurance  companies. 

After  disposing  of  the  reserves  and  the  policy 
claims,  you  will  find  in  the  annual  statement  blank, 
Convention  edition  of  1909  (which  means  the  form  of 
annual  statement  blank  which  was  adopted  at  the 
1909  session  of  the  National  Convention  of  Insurance 
Commissioners,  and  which  is  now  generally  used 
throughout  the  United  States),  an  item  of 

Due  and  unpaid  on  supplementary  contracts  not  in- 
volving life  contingencies 

You  will  note  that  this  is  similar  in  wording  to  the 
item  referring  to  the  amounts  not  yet  due  on  install- 
ment contracts,  with  the  exception  that  this  item  calls 
for  the  amounts  which  are  due  and  unpaid,  while  the 
former  item  referred  to  the  present  item  of  amounts 
not  yet  due.  The  present  item  is  also  intended  to  cover 
another  form  of  liability  which  you  will  find  in  your 
examination   of   the   smaller   and  the  more   recently 

[115] 


116        Examination  of  Insurance  Companies 

formed  life  insurance  companies.  I  refer  to  the  item 
of  amounts  due  on  what  are  called  "  Special  "  or 
^'Advisory  Board  "  contracts.  These  are  supplemen- 
tary agreements  which  have  been  entered  into  by  the 
insurance  company  with  a  certain  number  of  its  policy- 
holders, whereby  a  definite  amount  (usually  $1  per 
thousand  of  insurance  in  force)  is  set  aside  each  year 
and  a  special  fund  thereby  created,  the  proceeds  from 
which  are  shared  annually  by  the  policyholders  com- 
posing these  special  groups. 

It  is  usual  to  limit  these  groups  to  100  or  200  or  500 
shareholders,  and  each  man  who  takes  a  policy  for  a 
certain  amount  (usually  $5,000)  is  entitled  to  one  of 
these  shares.  It  has  been  the  custom  of  companies  in 
the  past  to  form  various  series  of  these  Advisory 
Board  contracts.  For  instance,  a  company  will  form  one 
group  which  it  will  call  the  United  States  group,  and 
agree  to  set  aside  each  year  $1  on  each  $1,000  of  insur- 
ance on  all  policies  written  and  in  force  in  the  United 
States ;  another  group  will  be  formed  called  the  State 
of  Indiana  group,  and  $1  or  $.50  will  be  set  aside  each 
year  for  each  $1,000  of  insurance  written  and  in  force 
in  that  State. 

It  will  be  apparent  to  you  that  this  system  entails 
a  serious  drain  upon  the  company,  but  it  has  been 
objected  to  for  another  reason ;  it  apparently  creates  a 
discrimination  between  the  policyholders,  and  a  recent 
summary  prepared  by  the  representative  of  a  number 
of  companies  indicates  that  in  reference  to  Advisory 
Board  contracts 

28   States  have  statutes  expressly  forbidding  them. 
9  States  have  forbidden  them  by  rulings  of  their 
Insurance  Departments. 


Examination  of  Insurance  Companies        117 

1  State  has  a  departmental  ruling  which  forbids 
them  unless  offered  to  all  policyholders  alike. 

1  State  has  a  decision  by  its  Supreme  Court  de- 
claring them  to  be  illegal  under  the  anti-dis- 
crimination statute. 

In  dealing  with  Advisory  Board  contracts  the  exam- 
iner should  realize  that  the  liability  under  them  arises 
from  two  sources :  first,  the  amounts  which  remain  in 
the  fund  and  are  undistributed  at  the  time  of  the 
examination  (as  a  usual  thing  the  policyholder  does 
not  receive  his  share  of  the  fund  until  he  pays  his  re- 
newal premium),  and  second,  the  amount  which  has 
accrued  in  the  fund  between  the  time  of  the  last  ascer- 
tainment and  the  date  of  the  examination. 

Premiums  paid  in  advance,  including  surrender  values 
so  applied 

This  refers  to  the  practice  which  some  policyholders 
have  of  paying  their  premiums  before  they  become 
due,  in  which  case  the  entire  premium  so  paid  in  ad- 
vance is  chargeable  as  a  liability.  The  reserve  on  a 
company's  policies  is  calculated  on  the  basis  of  the 
length  of  time  which  has  elapsed  between  the  date  of 
issue  and  the  date  of  the  examination;  it  follows  that 
if  any  premiums  have  been  paid  in  advance  of  their 
due  dates,  they  have  not  been  taken  into  account  in  the 
calculation  of  the  reserve.  It  becomes  necessary,  there- 
fore, to  charge  the  gross  amount  collected  from  the 
insured,  as  in  the  event  of  his  death  before  the  pre- 
mium becomes  due,  it  must  in  the  absence  of  any 
special  agreement  be  returned  to  his  beneficiary. 


118         Examination  of  Insurance  Companies 

Unearned  interest  and  rent  paid  in  advance 

You  will  recall  that  wlien  considering  the  assets  of 
a  company  we  gave  it  credit  for  the  accrued  interest 
on  its  policy  loans  and  also  for  the  rents  which  were 
due  and  accrued  on  the  real  estate  which  it  owned.  It 
is  the  practice  of  some  companies  to  insist  upon  the 
payment  of  interest  in  advance  by  the  policyholders 
who  effect  loans  upon  their  policy  contracts.  If  a 
policy  loan  were  made  on  July  1st  and  interest  col- 
lected for  a  year  in  advance  from  the  borrower,  you 
would  (if  your  examination  were  being  made  as  of 
December  31st  of  that  year)  charge  six  months'  un- 
earned interest  on  the  policy  loan.  This  is  consonant 
with  the  way  in  which  we  treated  accrued  interest.  In 
the  same  way  if  any  tenant  on  any  of  the  property 
owned  by  the  company  has  paid  his  rent  for  a  period 
beyond  the  date  of  the  examination,  the  unearned 
portion  of  that  payment  is  properly  chargeable  as  a 
liability. 

Commissions  due  to  agents  on  premium  notes  when 
paid 

We  allow  the  premium  notes  as  an  asset  and  do  not 
provide  for  any  deduction  for  commissions  as  we  do 
in  the  case  of  uncollected  and  deferred  premiums ;  it 
is  but  proper,  therefore,  that  the  company  should 
maintain  as  a  liability  the  commission  which  it  will 
have  to  pay  when  the  policyholder  liquidates  the  in- 
debtedness represented  by  the  premium  note. 

* '  Cost  of  collection  ' '  on  uncollected  and  deferred  pre- 
miums in  excess  of  the  loading  thereon 

You  will  recall  that  when  we  were  dealing  with 
the  subject  of  uncollected  and  deferred  premiums,  I 


Examination  of  Insurance  Companies        119 

pointed  out  that  we  deducted  the  loading  in  order  to 
bring  these  items  to  the  net  basis  which  was  used  in 
computing  the  reserve  liability  upon  the  policies.  In 
the  same  way  if  the  amount  which  the  company  will 
have  to  pay  in  the  future  on  its  uncollected  and  de- 
ferred premiums  exceed  the  loading,  a  correct  state- 
ment of  the  assets  and  liabilities  requires  that  we 
should  take  cognizance  of  this  condition  and  charge  as 
a  liability  the  difference  between  the  amount  which  the 
company  will  have  to  pay  out  for  collecting  this  asset 
and  the  loading  which  represents  the  expense  fund 
available  for  that  purpose. 

Salaries,  rents,  office  expenses,  bills  and  accounts  due 

or  accrued 
Medical  Examiners'  fees  and  legal  fees  due  or  accrued 

I  have  combined  these  two  items  for  they  deal  with 
practically  the  same  classes  of  items.  They  are  almost 
self-explanatory,  and  I  shall  therefore  confine  my  dis- 
cussion of  them  to  pointing  out  one  or  two  unusual 
items  which  should  nevertheless  be  included.  If  the 
taxes  on  the  real  estate  which  the  company  owns  have 
not  been  promptly  paid  they  should  be  charged  as  a 
liability.  If  the  company  has  ordered  merchandise, 
printed  matter  or  supplies  which  it  has  received  before 
the  date  of  the  examination,  the  bills  for  them  are 
properly  chargeable  as  a  liability,  even  though  the  bills 
have  not  been  rendered  or  if  they  bear  a  date  subse- 
quent to  the  date  of  the  examination.  You  can  readily 
see  that  it  would  not  be  proper  for  us  to  take  any  cog- 
nizance of  any  arrangement  which  had  been  entered 
into  between  the  company  and  the  one  who  furnished 
the  supplies  as  to  when  the  bill  should  be  dated. 


120        Examination  of  Insurance  Companies 

State,  county  and  municipal  taxes  due  or  accrued 

In  considering  this  item  it  will  be  necessary  to  con- 
sider it  under  two  headings.  The  taxes  which  a  life 
insurance  company  is  called  upon  to  pay  may  either  be 
in  the  nature  of  a  penalty  which  the  State  exacts  for 
transactions  of  the  past,  or  they  may  be  in  the  nature 
of  a  franchise  or  occupation  tax  for  its  future  trans- 
actions. Taxes  which  can  be  referred  to  the  first  class 
are  surely  a  liability  at  the  time  of  the  examination, 
but  taxes  answering  to  the  latter  description  are  not, 
in  my  opinion,  to  be  considered  as  liabilities  outstand- 
ing at  the  time  of  the  examination,  even  though  they 
be  calculated  upon  the  basis  of  premium  collections  in 
the  past. 

Advances  by  officers  or  others  on  account  of  expenses 
of  organization  or  otherwise 

In  the  case  of  newly  established  companies  you 
may  find  that  some  agreement  has  been  made  with 
its  ofl&cers  or  organizers  whereby  certain  sums  are  to 
be  paid  to  them  after  the  company  has  started  to 
transact  its  business.  In  these  cases  the  amounts  so 
promised  are  liabilities  of  the  corporation  and  should 
be  so  considered. 

Borrowed  money  and  interest  thereon 

I  consider  it  almost  unnecessary  for  me  to  discuss 
the  question  of  the  liability  arising  from  this  source, 
but  I  merely  wish  to  call  your  attention  to  it  as  in  some 
cases  the  presence  of  an  item  of  borrowed  money  may 
render  the  balancing  of  the  statement  difficult.  In 
former  years   the  blanks   provided   for   a   deduction 


Examination  of  Insurance  Companies        121 

from  the  "  ledger  assets  "  in  order  that  the  statement 
might  be  brought  in  balance  with  the  result  which 
was  obtained  by  adding  or  deducting  the  difference 
between  the  income  and  the  disbursements  to  or  from 
the  ledger  assets  of  the  previous  year.  The  present 
form  of  blank  disregards  the  question  of  *'  ledger 
liabilities,"  and  in  the  case  of  a  company  which  has 
borrowed  money  the  statement  will  not  balance  unless 
the  amount  so  borrowed  is  included  in  the  income. 
Some  question  exists  as  to  the  propriety  of  consider- 
ing borrowed  money  as  a  source  of  income,  and  I 
think  in  every  properly  kept  set  of  books  the  '*  bills 
payable  "  should  receive  the  same  treatment  as  the 
'*  bills  receivable." 

Unpaid  dividends  to  stockholders 

If  a  company  has  declared  a  dividend  payable  to  its 
stockholders  on  a  certain  date  it  is  customary  to  charge 
the  total  amount  of  the  dividend  declaration  as  a  liabil- 
ity, even  though  the  date  of  payment  may  fall  beyond 
the  date  of  the  examination.  You  will  also  find  that  in 
a  number  of  corporations  it  is  impossible  to  locate 
some  of  their  stockholders  or  fractional  shares  of 
stock  are  outstanding  and  dividends  are  payable 
thereon.  In  those  cases  the  unpaid  dividends  are 
charged  as  a  liability. 

Capital  stock 

All  of  the  capital  stock  which  has  been  issued  is  a 
liability  of  an  insurance  company.  The  proper  way  in 
which  to  ascertain  the  amount  of  the  outstanding  stock 
is  not  by  accepting  the  statement  of  the  controlling 


122        Examination  of  Insueance  Companies 

account  in  the  general  ledger  or  even  the  statement  as 
it  appears  in  the  stock  ledger  of  the  company;  we 
should  work  directly  from  the  stubs  in  the  stock  cer- 
tificate book.  When  a  certificate  of  stock  has  been  re- 
turned for  cancellation  it  should  be  attached  to  its 
stub;  the  stubs,  therefore,  which  have  no  certificates 
attached  to  them,  should  indicate  the  number  of  shares 
outstanding  and  the  liability  can  be  computed  directly 
therefrom.  Of  course,  in  the  case  of  companies  which 
have  been  established  for  a  great  many  years,  it  is  not 
unusual  that  some  of  the  old  certificates  should  be 
missing.  You  will  be  able  to  decide,  however,  whether 
these  exceptional  cases  are  the  result  of  error  or  of 
design. 

Among  some  of  the  recently  established  companies 
you  will  find  that  the  stock  has  been  sold  to  investors 
and  to  policyholders  by  stock  salesmen  who  have  in 
most  cases  used  estimates  of  future  earnings  which 
will  never  be  realized  and  which  have  awakened  false 
hopes  in  the  minds  of  those  who  purchased  the  stock. 
This  has  been  frowned  upon  by  practically  every  In- 
surance Commissioner,  and  a  circular  similar  to  the 
one  which  I  quoted  in  the  matter  of  Advisory  Board 
contracts  has  been  issued,  from  which  the  following  in- 
formation relative  to  the  sale  of  stock  in  connection 
with  life  insurance  has  been  taken: 

26  States  have  expressly  forbidden  it  by  statute. 

7  States  have  Insurance  Department  rulings  for- 
bidding it. 

1  State  has  a  departmental  ruling  forbidding  it 
unless  offered  to  all  policyholders  alike. 

1  State  has  an  Attorney-General's  opinion  de- 
claring it  to  be  illegal. 


Examination  of  Insurance  Companies        123 

1  State  has  an  Attorney-General's  opinion  de- 
claring it  to  be  illegal  unless  the  option  for 
the  purchase  of  the  stock  is  contained  in  the 
policy  contract. 

In  these  cases  you  may  find  that  the  purchasers  of 
the  stock  have  made  partial  payments  on  account,  and 
if  the  certificates  have  not  been  issued  it  will  be  neces- 
sary to  charge  these  advance  payments  as  a  liability. 

XJnassigned  funds  (surplus) 

are,  of  course,  the  balance  between  the  sum  of  all  the 
liabilities  and  the  admitted  assets ;  the  admitted  assets 
you  will  recall  are  the  result  of  deducting  the  non- 
admitted  assets  from  the  gross  assets.  In  previous 
years  the  annual  statement  blanks  referred  to  this 
item  as  ''  gross  divisible  surplus."  I  mention  this 
lest  the  different  designation  may  cause  some  confu- 
sion in  your  minds. 


CHAPTER  XV 

Commissions  on  Uncollected  Premiums  —  Dividend 
Liabilities  of  Life  Companies  — Annual  and  Deferred 
Dividends  —  Restrictions  Placed  on  Dividends  by 
New  York  Statutes  —  By  Ohio  Statutes  —  Items  of 
Dividend  Liability  in  Statement  Blank  —  Tontine 
Policies  —  Sources  of  Dividends. 

An  examination  of  the  liabilities  charged  against 
companies  which  transact  other  than  a  life  insurance 
business  will  indicate  that  there  are  no  additional 
points  which  require  our  consideration,  with  the  pos- 
sible exception  of  the  commissions  or  brokerage  which 
are  charged  against  the  premiums  in  course  of  collec- 
tion. As  we  gave  the  company  credit  only  for  those 
premiums  which  were  less  than  three  months  past  due, 
we  must  be  careful  to  charge  as  a  liability  the  com- 
missions which  will  have  to  be  paid,  on  only  those  pre- 
miums which  have  been  allowed  as  an  asset. 

You  will  recall  that  in  separating  the  liabilities  into 
four  groups  I  referred  to  the  dividend  liabilities ;  this 
group  applies  only  to  life  insurance  contracts. 

Life  insurance  policies  are  issued  either  upon  the 
non-participating  or  the  participating  plan;  as  the  pol- 
icyholder is  not  entitled  to  any  share  of  the  profits  on 
non-participating  policies  the  premiums  charged  are 
naturally  lower.  Participating  policies  are  subdivided 
into  two  divisions  —  those  providing  for  annual  divi- 
dends and  those  providing  that  the  apportionment,  or 

[124] 


Examination  of  Insurance  Companies        125 

rather  payment,  of  proj&ts  shall  be  deferred  until  some 
date  in  the  future. 

The  question  of  dividends  assumed  considerable  im- 
portance during  the  investigation  of  life  insurance 
companies  about  five  years  ago.  It  was  felt  that  the 
holding  of  large  surpluses,  without  the  necessity  of  an 
accounting  between  the  time  that  the  policies  were 
issued  and  the  time  that  the  deferred  dividend  periods 
matured,  was  responsible  in  a  large  measure  for  the 
evils  which  existed. 

Until  that  time  companies  felt  at  liberty  to  use  that 
form  of  dividend  distribution  which  they  felt  was  most 
desirable.  Some  have  always  issued  annual  dividend 
contracts,  while  others  have  discouraged  the  issuance 
of  anything  but  deferred  dividend  contracts.  As  a 
result  of  the  investigation  just  referred  to,  statutes 
were  enacted  in  a  number  of  States  which  have  had 
the  effect  of  abolishing  the  deferred  dividend  method 
of  distribution. 

In  New  York,  for  instance,  two  statutes  were  placed 
upon  the  books  which  have  a  bearing  upon  this  ques- 
tion. We  find  that  section  87  (see  Appendix  M)  speci- 
fies the  amount  of  the  contingency  reserve  which  a 
domestic  life  insurance  corporation  may  hold,  limiting 
the  amount  to  certain  definite  figures  dependent  upon 
the  size  of  the  company.  As  the  contingency  reserve 
indicates  the  maximum  amount  which  the  companies 
may  hold  in  excess  of  their  liabilities,  it  follows,  of 
course,  that  the  balance  must  be  distributed  (except  in 
the  cases  of  emergency  referred  to  in  the  statute)  in 
the  form  of  dividends. 

The  New  York  Insurance  Law  by  section  101  pre- 
scribes the  standard  forms  of  policies  which  may  be 


126        Examination  of  Insurance  Companies 

used  by  domestic  life  insurance  companies  in  the  State, 
and  you  will  find  that  one  of  the  conditions  in  these 
standard  forms  is  that  the  policy  shall  participate  each 
year  in  the  surplus  of  the  company.  The  effect  of 
these  requirements,  you  will  see,  is  to  provide  for  a 
system  of  supervision  over  the  funds  which  the  com- 
pany may  accumulate  in  excess  of  the  reserve  require- 
ments and  the  necessity  for  other  definite  forms  of 
liability.  Formerly  large  sums  of  money,  amounting 
in  some  cases  to  millions  of  dollars,  had  been  accumu- 
lated for  the  purpose  of  distribution  some  time  in  the 
future,  and  no  form  of  supervision  over  them  had  been 
exercised ;  the  officers  had  a  free  hand  in  the  matter  of 
the  investment  of  these  funds  and  their  subsequent 
distribution. 

The  adoption  of  the  standard  forms  of  policy  in  the 
State  of  New  York,  was  followed  by  a  similar  action 
in  a  number  of  the  other  States.  In  Ohio,  for  instance, 
the  General  Assembly  passed  an  act  requiring  the  use 
of  standard  forms,  or  if  any  company  did  not  care  to 
use  them,  it  could  issue  any  other  form  provided  it 
contained  certain  standard  provisions  and  did  not  con- 
tain certain  other  prohibited  conditions.  Among  the 
standard  conditions  which  every  life  insurance  com- 
pany issuing  participating  policies  in  Ohio  must  have 
in  its  contract,  is  the  one  which  provides  that  the 
policy  shall  participate  annually  in  the  surplus,  begin- 
ning at  a  time  not  later  than  the  end  of  the  third  policy 
year  (see  Appendix  N).  The  two  exceptions  to  this 
form  of  distribution  are,  first,  the  policies  which  by 
their  terms  provides  for  a  distribution  made  at  the 
end  of  the  fifth  policy  year  and  quinquennially  there- 
after, and  second,  renewable  term  policies  of  ten  years 
or  less. 


Examination  op  Insurance  Companies        127 

These  two  exceptions  were  made,  I  believe,  because 
it  was  felt  that  in  the  cases  of  five  year  dividend  poli- 
cies the  amount  which  could  be  accumulated  without 
an  accounting  being  made  to  the  policyholder,  was  lim- 
ited in  amount ;  in  the  same  way  the  premiums  on  term 
insurance  policies  do  not  usually  contain  a  suflficiently 
large  surplus  factor  to  render  the  dividend  question 
important. 

Until  1907  all  of  the  surplus  profits  belonging  to 
policyholders  were  carried  in  the  general  surplus  of 
the  company  and  included  in  the  item  of  unassigned 
funds.  After  1907  the  separation  was  insisted  upon 
and  we  now  find  in  the  annual  statement  blanks  which 
are  used  by  life  insurance  companies  four  items  refer- 
ring specifically  to  the  matter  of  dividends. 

The  first  one 

''  Dividends  or  other  profits  due  policyholders, 
including  those  contingent  on  payment  of  out- 
standing and  deferred  premiums  " 

refers  to  those  dividends  which  have  already  been  de- 
clared, but  which  have  not  been  paid  to  the  policy- 
holder at  the  time  that  the  statement  was  made. 
The  second 

"  Dividends  declared  on  or  apportioned  to 
annual  dividend  policies  payable  to  policyholders 
during  1910,  whether  contingent  upon  the  pay- 
ment of  renewal  premiums  or  otherwise  " 

is  self-explanatory,  but  you  will  note  that  it  applies 
to  annual  dividend  policies  only.  The  year  1910,  which 
has  been  inserted  here  will  change  each  year,  and  I 
have  used  the  figure  which  appears  in  the  annual  state- 


128        Examination  of  Insurance  Companies 

ment  blank  showing  the  condition  of  the  company  as 
of  December  31,  1909,  in  order  that  the  time  of  the 
application  of  the  liability  may  be  clear  to  you;  these 
remarks  apply  with  equal  force  to  the  date  used  in 
the  next  item. 
The  third  item 

''  Dividends  declared  on  or  apportioned  to 
deferred  dividend  policies  payable  to  policy- 
holders during  1910  '* 

is  the  item  which  corresponds  to  the  one  just  referred 
to,  but  it  is  applicable  to  the  deferred  dividend  con- 
tracts only. 

The  fourth  item 

**  Amounts  set  apart,  apportioned,  provisionally 
ascertained,  calculated,  declared  or  held  awaiting 
apportionment  upon  deferred  dividend  policies, 
not  included  in  item  33  " 

is  probably  the  most  important  one  and  marks  the 
radical  change  in  the  manner  of  treating  dividends, 
to  which  I  have  referred  previously,  as  a  result  of  the 
investigations  which  have  been  made.  Item  33  refers 
to  the  preceding  item  (designated  by  me  as  the  third 
item),  and  the  numbering  is  the  one  employed  in  the 
1909  convention  edition.  A  proper  consideration  of 
this  item  will  require  a  brief  description  of  the  devel- 
opment of  deferred  dividend  business  in  this  country. 
The  first  issues  of  deferred  dividend  or  tontine  (this 
word  is  derived  from  the  name  of  an  Italian  banker, 
Lorenzo  Tonti,  who  in  the  seventeenth  century  sug- 
gested to  the  King  of  France  that  a  number  of  indi- 
viduals should  each  contribute  to  a  fund,  the  annual 


Examination  op  Insubance  Companies        129 

income  of  wliich  was  to  be  divided  among  the  sur- 
vivors of  the  original  contributors  and  when  no  sur- 
vivors remained,  the  fund  was  to  revert  to  the  State) 
policies  provided  for  the  payment  of  the  face  of  the 
policies  to  the  estates  of  those  policyholders  who  died 
before  the  completion  of  the  tontine  period;  the  entire 
profits  were  divided  among  those  policyholders  who 
were  alive  at  the  completion  of  their  dividend  periods, 
and  who  had  persisted  in  the  payment  of  their  pre- 
miums until  that  time.  Those  policyholders  who 
through  choice  or  necessity  did  not  continue  their  pre- 
mium payments,  forfeited  not  only  their  share  in  the 
profits,  but  also  the  reserve  which  had  been  accumu- 
lated on  their  contracts. 

The  iniquity  of  this  method  was  apparent  and  the 
policy  contracts  were  then  changed  to  provide  that  if 
a  policyholder  lapsed  after  making  a  certain  number 
of  premium  payments,  his  equity  in  the  reserve  which 
had  been  accumulated  on  his  policy,  should  be  recog- 
nized; he  was,  therefore,  given  the  right  to  receive  a 
certain  amount  of  paid-up  insurance  depending  upon 
his  age,  amount  of  reserve  which  had  been  accumu- 
lated and  the  surrender  charge  which  was  exacted  by 
the  company.  Subsequently  nearly  all  of  the  States 
passed  statutes  requiring  companies  to  grant  these 
values  in  the  case  of  lapsed  policies,  section  88  of  the 
New  York  Insurance  Law  being  typical  of  this  class 
of  enactments. 

The  fourth  item  before  referred  to,  you  will  see 
requires  the  company  to  set  aside  the  amounts  which 
it  is  holding  for  its  deferred  dividend  policyholders; 
in  this  way  these  become  specific  liabilities  of  the  com- 

9 


130        Examination  of  Insurance  Companies 

pany  and  cannot  be  included  in  its  general  surplus 
or  the  unassigned  funds. 

Although  the  computation  of  the  dividends  is  a  mat- 
ter which  you  will  probably  refer  to  your  actuarial 
adviser,  it  is  but  proper  that  you  should  have  a  gen- 
eral idea  of  the  manner  in  which  the  dividends  on  life 
insurance  policies  are  obtained. 

The  sources  from  which  policyholders  derive  their 
dividends  are 

1.  Savings  from  mortality. 

2.  Excess  interest  earnings. 

3.  Savings  from  loading. 

I  have  already  explained  to  you  that  one  of  the 
factors  upon  which  the   calculation  of  premiums  is 
based,  is  a  mortality  table.     This  mortality  table  as- 
sumes that  during  the  year  a  certain  number  of  in- 
sured lives  will  die.    If  in  the  particular  company  the 
agents  have  been  careful  to  select  policyholders  in- 
volving no  moral  hazard  and  the  examining  physicians 
have  been  careful  to  approve  the  applications  of  those 
applicants  only  who  have  no  marked  iDhysical  defects, 
the  company  will  experience  a  mortality  less  than  that 
assumed  by  the  table  upon  which  its  premiums  were 
calculated.    It  must  be  apparent  to  you  that  a  profit 
will  arise  from  such  a  condition  of  affairs;  in  a  well- 
managed,  active  company,  the  actual  mortality  ought 
to  be  between  60  per  cent,  and  80  per  cent,  of  the  ex- 
pected mortality,  in  some  years  rising  and  in  others 
falling,  through  no  traceable  cause. 

The  second  source  of  dividends  arises  from  the  ex- 
cess interest  earnings,  and  you  will  recall  that  the  in- 
terest factor  is  one  which  is  taken  into  account  in  the 


Examination  of  Insurance  Companies        131 

calculation  of  the  premiums.  A  company  bases  its 
premiums  upon  a  certain  mortality  table  and  upon  a 
definite  rate  of  interest,  3  per  cent,  or  31/2  per  cent,  or 
4  per  cent.  K  the  premium  receipts  and  the  reserve 
funds  of  the  company  are  in«^;^ested  in  such  a  manner 
as  to  earn  a  net  rate  of  interest  in  excess  of  the  one 
assumed  in  the  premium  calculation,  the  excess  over 
that  rate  is  a  source  of  profit.  I  have  referred  to  the 
net  rate  in  order  to  call  your  attention  to  the  fact  that 
we  must  take  into  account  the  investment  expenses 
and  the  investment  losses  in  determining  the  rate  of 
interest  earned. 

The  third  source  is  the  saving  in  loading.  You  will 
recall  that  the  insured  pays  a  gross  or  office  premium, 
which  is  divided  into  two  parts,  the  mathematical  net 
premium  and  the  loading;  the  object  of  the  first  part 
is  to  pay  the  current  death  losses  and  to  provide  for 
the  accumulation  of  the  reserve  necessary  to  pay  each 
policy  at  its  maturity;  the  loading  is  the  difference 
between  the  mathematical  net  premium  and  the  gross 
premium  and  is  added  to  the  net  premium  for  the  pur- 
pose of  taking  care  of  all  of  the  expenses  and  contin- 
gencies not  provided  for  by  the  net  premium  portion. 
If,  therefore,  a  company  should  be  able  to  so  admin- 
ister its  affairs  as  to  effect  a  saving  in  the  expense 
loading,  it  will  be  apparent  to  you  that  such  saving 
will  constitute  a  source  of  profit. 

From  these  three  factors  are  derived  the  dividends 
payable  to  policyholders,  but  the  factors  themselves 
and  the  manner  of  applying  them,  are  matters  of  opin- 
ion which  vary  according  to  the  wishes  of  the  actuary 
in  charge  of  the  company. 

There  is  another  factor  which  I  have  not  deemed  it 


132        ExAMiNATioisr  OF  Insurance  Companies 

necessary  to  discuss  as  one  of  the  sources  of  dividends. 
I  refer  to  the  profit  which  naay  accrue  to  a  company 
through  the  failure  of  its  policyholders  to  continue 
their  premium  payments.  In  former  years,  the  profit 
from  lapses  was  considerable,  but  the  stress  of  com- 
petition and  the  passage  of  laws  in  the  various  States 
affecting  this  question,  have  reduced  these  profits  to 
almost  a  negligible  quantity.  The  initial  cost  of  plac- 
ing business  on  the  books  is  so  heavy  that  the  loading 
factor  is  not  sufficient  to  provide  for  it.  If,  therefore, 
a  lapsing  policyholder  leaves  any  of  his  reserve  in  the 
hands  of  the  insurance  company,  it  is  but  proper  to 
use  it  as  an  off-set  to  the  procurement  expenses.  It  is 
the  practice  of  some  actuaries  in  computing  the  sav- 
ings in  mortality  to  take  into  account  this  lapse  factor. 


CHAPTER  XVI 

Departmental  Examinations  not  Audits  —  The  Trial 
Balance  —  Premium  Income  —  The  Two  Bases  — 
*'  Policyholders'  Basis  " — Various  Sources  of  Inter- 
est —  Other  Items  of  Income  —  Premium  on  Capital 
Stock. 

It  is  my  intention  to  refer  briefly  to  the  various 
items  in  the  income  and  the  disbursement  portions  of 
the  annual  statement  blanks  in  order  that  you  may  get 
a  proper  idea  of  the  relation  which  these  items  bear 
to  the  other  portions  of  the  blank. 

As  I  have  previously  stated,  an  examination  by  an 
Insurance  Department  is  not  an  audit  in  the  sense  that 
the  term  is  usually  understood;  at  the  same  time  the 
examiner  is  vitally  interested  in  feeling  sure  that  the 
books  shown  to  him  can  be  relied  upon  as  containing  a 
true  exhibit  of  the  various  transactions. 

In  this,  as  in  the  other  talks  which  I  have  made,  you 
will  notice  references  to  the  misleading  methods  which 
have  sometimes  been  followed  by  the  companies  under 
examination;  it  must  not  be  assumed  from  this  that 
the  examiner  should  be  prepared  to  find  improper  con- 
ditions in  every  office  visited  by  him,  but  did  he  not 
take  all  possible  precautions  to  satisfy  himself  that  the 
books  were  properly  kept,  he  would  be  valueless  for 
the  work  which  he  is  undertaking.  He  is  somewhat  in 
the  position  of  a  physician  making  an  examination  of 
an  applicant  for  life  insurance:  the  doctor  does  not 

[133] 


134        Examination  of  Insueance  Companies 

expect  to  find  an  impaired  risk,  but  his  duty  to  his 
employer  requires  that  he  shall  be  alert  and  that  his 
eye  shall  be  constantly  on  the  lookout  for  imperfec- 
tions; in  fact,  no  one  but  the  wrongdoer  objects  to  a 
hypercritical  attitude  upon  the  part  of  the  examiner. 

Before  taking  up  the  matter  of  the  items  of  income, 
however,  I  desire  to  refer  briefly  to  some  of  the  gen- 
eral rules  for  examining  the  books  of  record.  It  is 
almost  unnecessary  for  me  to  call  your  attention  to  the 
fact  that  we  should  be  satisfied  that  the  footings  in  all 
books  submitted  to  us  have  been  correctly  made.  In 
some  cases  it  will  be  necessary  to  verify  everything, 
while  in  other  cases  adequate  tests  can  be  made  which 
will  serve  to  answer  all  purposes;  if  the  books  of  the 
corporation  are  audited  periodically  by  competent  ac- 
countants and  auditors,  the  work  of  the  examiner  is 
much  simplified,  for  if  the  methods  of  investigation 
which  have  been  pursued  by  these  outside  auditors 
commend  themselves,  he  may  feel  safe  in  accej^ting 
their  certificate. 

As  a  general  proposition  it  may  be  stated  that  every 
debit  balance  indicates  either  an  item  of  disbursements 
or  an  item  of  assets,  while  every  credit  balance  indi- 
cates an  item  of  income  or  an  item  of  liabilities.  This 
rule,  however,  may  be  modified  by  the  peculiar 
methods  followed  in  some  particular  companies.  Some 
books,  for  instance,  are  kept  in  such  a  way  as  to  re- 
quire the  use  of  each  side  of  the  account  instead  of  the 
balance ;  in  other  words,  we  may  find  that  accounts  are 
not  closed  out  at  the  end  of  each  financial  period,  and 
in  those  cases  we  must  use  the  increase  or  decrease  in 
the  account  for  the  corresponding  items  in  the  annual 
statement.    If  the  general  system  of  accounting,  how- 


Examination  of  Insurance  Companies        135 

ever,  is  understood  by  the  examiner  and  kept  con- 
stantly in  his  mind,  he  will  have  no  difficulty  in  apply- 
ing these  general  principles  to  each  particular  system. 

The  most  important  item  of  income  for  insurance 
companies  is  naturally  the  premium  income,  and  the 
treatment  accorded  this  item  varies  with  the  different 
kinds  of  insurance  transacted.  I  think  I  have  already 
mentioned  to  you  that  in  the  case  of  life  insurance 
companies  the  assets  are  computed  upon  the  basis  of 
the  cash  which  has  been  received,  and  in  consequence 
the  premium  income  portion  of  the  statement  is  upon 
the  same  basis;  in  the  case  of  other  forms  of  insur- 
ance, the  assets  are  computed  on  the  basis  of  the 
premiums  which  have  been  written,  even  though  they 
have  not  been  received  in  cash,  and  we  therefore  pre- 
pare the  income  portion  accordingly. 

To  bring  the  distinction  clearly  before  you  let  me 
assume  the  case  of  two  insurance  companies,  one 
transacting  a  life  business  and  the  other  a  fire  busi- 
ness, both  starting  in  December  of  any  year  and  before 
the  close  of  that  year  each  has  issued  one  policy  upon 
which  the  premium  of  $100  has  not  been  collected.  For 
the  sake  of  illustration  we  will  assume  that  no  moneys 
have  been  paid  out  for  expenses  and  that  no  other 
transactions  of  any  kind  have  taken  place. 

In  the  case  of  a  life  insurance  company  the  premium 
income  would  be  zero,  the  disbursements  would  be 
zero  and  the  ledger  assets  would  be  zero ;  in  the  non- 
ledger  assets,  however,  we  would  find  the  uncollected 
premium  scheduled  as  a  credit,  the  deduction  made  for 
loading,  and  in  the  liabilities  we  would  find  the  reserve. 

In  the  case  of  a  fire  insurance  company,  however, 
the  premium  income  would  show  $100,  the  disburse- 


136        Examination  of  Insurance  Companies 

ments  zero,  and  among  tlie  ledger  assets  we  would  find 
a  credit  of  $100  for  "  agents'  balances  not  more  than 
three  months  past  due,"  thus  making  the  statement 
balance;  among  the  liabilities  we  would  find  the  un- 
earned premium  and  the  commission  or  brokerage  due 
the  agent  charged  in  their  appropriate  places.  In 
some  fire  offices  it  is  the  practice  to  give  the  agent 
credit  for  the  commission  as  soon  as  he  is  charged 
with  the  premium,  and  in  that  case  the  premium  in- 
come would  be  $100,  the  commissions  would  appear  in 
the  disbursement  portion  as  $30  (if  that  be  the  rate 
allowed),  and  among  the  ledger  assets  we  would  find 
the  agents'  balances  stated  at  the  net  figure,  $70,  the 
balance  being  thus  maintained;  in  this  case,  however, 
you  will  note  that  the  only  item  of  liabilities  to  be 
charged  is  the  unearned  premium. 

It  is  important  that  we  should  bear  in  mind  the 
manner  in  which  unscrupulous  officers  or  employees 
can  profit  by  incorrect  entries  in  the  books;  the  most 
usual  method  is  the  overstatement  of  disbursements, 
the  peculator  profiting  by  the  use  of  sums  of  money 
which  are  charged  to  other  and  more  innocent  ac- 
counts ;  it  must  be  apparent  to  you,  however,  that  the 
same  results  can  be  accomplished  by  understating  the 
receipts.  That  this  is  not  merely  an  academic  question 
can  be  realized  when  I  explain  to  you  that  the  use  of 
large  sums  of  money  for  legislative  purposes  by  one 
of  the  large  insurance  corporations  was  accomplished 
by  failing  to  report  as  an  item  of  income,  the  policy 
fees  which  had  been  received,  thus  saving  itself  the 
necessity  of  setting  forth  the  outlay  in  the  disburse- 
ment portion  of  this  statement.  It  is  important,  there- 
fore, that  we  should  take  the  necessary  steps  to  ascer- 


Examination  op  Insurance  Companies        137 

tain  that  all  of  the  items  of  income  have  been  correctly 
set  forth  in  the  books  and  the  statements. 

In  the  case  of  all  insurance  companies,  the  premium 
income  is  stated  on  the  policyholders'  basis.  By  the 
use  of  the  term  ' '  policyholders '  basis  ' '  I  wish  to  con- 
vey the  idea  that  the  reports  show  the  premiums  writ- 
ten or  received  (as  the  case  may  be)  after  deducting 
the  reinsurance,  the  return  premiums  and  the  pre- 
miums  on  not  taken  policies;  I  use  this  term  to  distin- 
guish these  disbursements  from  the  other  deductions 
which  are  made  and  which  are  purely  of  an  agency  or 
managerial  nature.  In  the  case  of  life  insurance  com- 
panies, the  deduction  which  is  made  is  for  reinsurance 
only,  i.  e.,  for  the  premiums  which  the  company  under 
examination  has  had  to  pay  to  some  other  company 
for  having  the  latter  assume  part  of  the  risk;  in  the 
case  of  life  insurance  companies,  we  do  not  have  return 
premiums  as  a  usual  thing,  or  any  of  the  other  deduc- 
tions which  you  will  find  are  made  in  the  case  of  com- 
panies transacting  the  other  forms.  The  reason  for 
this  is  apparent  when  we  consider  that  a  life  insurance 
contract  may  not  be  canceled  by  the  company  which 
has  issued  it  except  for  fraud ;  if  the  person  who  has 
been  insured  has  made  proper  representations  to  the 
company  at  the  time  that  the  policy  was  issued  and 
he  continues  to  pay  his  premiums,  there  is  no  way  in 
which  the  company  can  void  the  contract  or  escape 
carrying  the  risk.  On  the  other  hand,  if  a  company 
transacting  other  forms  of  business  should  desire  for 
any  reason  to  get  off  a  risk,  it  can  do  so  by  serving 
the  proper  notice  upon  the  legal  holder  of  the  policy 
and  returning  the  portion  of  the  premium  which  has 
not  been  earned. 


138        Examination  of  Insurance  Companies 

As  a  result  of  the  foregoing  condition  it  is  necessary 
for  the  statement  blanks  relating  to  companies  other 
than  life  insurance  companies,  to  contain  items  which 
show  definitely  how  much  has  been  returned  to  the  in- 
sured in  the  manner  which  I  have  just  described,  and 
as  their  statements  are  on  a  "  written  "  basis  instead 
of  a  '*  received  "  basis,  it  is  necessary  for  the  pre- 
mium exhibit  to  contain  an  item  of  the  premiums  on 
''  not  taken  "  policies,  i.  e.,  the  premiums  on  the  pol- 
icies which  have  been  issued  but  which  for  some  reason 
or  other  have  not  been  paid  for  by  the  insured  and 
have  been  returned  by  the  agent  for  cancellation.  You 
will,  of  course,  see  the  propriety,  in  fact  the  necessity, 
of  this  treatment  if  we  are  to  account  for  all  the  pre- 
miums written. 

In  a  previous  talk  I  referred  to  the  two  bases  upon 
which  life  insurance  companies  in  this  country  were 
required  to  report  their  condition,  one  the  written  and 
the  other  the  paid  for.  These  terms  apply  to  the  un- 
collected premiums  and  the  reserve  calculations  of  life 
insurance  companies,  and  must  not  be  confused  with 
the  "  written  basis  "  and  ''  received  basis  "  which 
refer  to  the  methods  of  treating  premiums. 

The  other  item  of  importance  in  the  income  state- 
ments of  insurance  companies  is  the  matter  of  interest, 
and  this  is  subdivided  into  the  various  sources  —  real 
estate,  mortgages,  bonds  and  stocks,  collateral  loans, 
etc.  There  is  no  necessity  for  any  extended  comment 
by  me  upon  the  method  of  verifying  this  item,  for  it  is 
merely  a  question  of  ascertaining  the  correctness  of 
the  entries  which  have  been  made.  The  annual  state- 
ment blanks  are  now  prepared  in  such  a  way  as  to 
include  schedules  showing  the  various  forms  of  in- 


Examination  of  Insukance  Companies        139 

vested  assets,  and  these  schedules  contain  calculations 
which  exhibit  very  clearly  the  amount  of  interest  which 
has  been  collected  during  the  year;  the  sum  of  these 
items  in  the  schedules  will  agree  with  the  interest 
items  in  the  income  portion  of  the  statement. 

There  are  other  items  of  income  which  are  unusual, 
but  which  may  be  found  from  time  to  time  in  a  com- 
pany's statement.  For  instance,  if  a  company  has 
some  time  in  the  past  marked  off  an  item  to  its  profit 
and  loss  account,  having  considered  it  valueless,  and 
a  subsequent  recovery  in  part  or  in  whole  has  been 
made,  the  amount  so  recovered  must  appear  among 
the  income  items  in  order  to  make  the  statement 
balance. 

If  any  invested  assets  have  been  sold  or  have  ma- 
tured during  the  period  covered  by  the  statement,  and 
as  a  result  have  shown  a  profit,  we  would  naturally 
expect  to  find  such  items  of  profit  in  the  income  por- 
tion of  the  statement.  You  will  recall  that  when  I 
dealt  with  the  proper  method  of  amortizing  bonds,  I 
called  your  attention  to  the  fact  that  if  a  security 
were  purchased  below  par,  it  would  be  necessary  to  in 
crease  the  original  book  value  each  year  in  order  that 
the  book  value  at  the  time  of  maturity  should  be  par; 
these  various  items  of  accumulation  are  proper  sources 
of  income  and  should  be  so  scheduled.  In  the  same 
way,  if  any  security  not  subject  to  the  process  of  amor- 
tization (real  estate  or  stocks,  for  instance)  should 
have  its  book  value  increased,  the  amount  of  such  in- 
crease should  be  included  among  the  income  items. 

I  desire  to  refer  to  another  item  which  may  be  met 
frequently  in  the  case  of  newly  established  companies, 
and  that  is  the  premium  which  has  been  paid  by  the 


rr "HE  \ 

I'NIVr.RSITY  !j 


OF  Jr' 


140        Examination  of  Insurance  Companies 

stockholders  upon  any  capital  stock  which  has  been 
sold  during  the  period  covered  by  the  statement.  If, 
for  instance,  the  capital  stock  of  the  company  has  been 
increased  by  $100,000,  and  the  newstock  has  been  sold 
at  the  rate  of  $150  per  share  (par  value  $100),  the 
difference  between  the  par  value  and  the  price  paid 
by  the  purchaser  —  $50  —  must  be  carried  as  an  item 
of  income.  The  par  value  becomes  part  of  the  capital 
stock  and  is  charged  as  a  liability,  but  there  is  no 
liability  attaching  to  the  surplus  portion  which  has 
been  contributed  by  the  stockholders ;  it  is,  therefore, 
an  item  of  income  which  may  be  used  for  managerial 
expenses  in  contrast  with  the  capital  stock  portion, 
which  at  all  times  remains  a  liability  and  must  not  be 
impaired  by  disbursements. 


CHAPTER  XVII 

Evidence  of  Disbursements  —  Voucher-cheques  — 
Losses  —  Payments  in  Installments  —  Net  Losses, 
Surrender  Values  and  Dividends  —  Other  Disburse- 
ments—  Profit  and  Loss. 

For  every  item  which  appears  among  the  disburse- 
ments of  an  insurance  company  (with  the  exception 
of  the  profit  and  loss  entries)  we  should  find  some  evi- 
dence of  payment.  This  evidence  may  take  the  form 
of  a  receipt  or  a  cheque,  and  the  tendency  among  com- 
panies to-day  is  toward  the  use  of  a  combination 
voucher-cheque,  which  when  properly  indorsed  by  the 
payee  becomes  a  cheque  which  can  be  deposited  in  a 
bank. 

We  should  not  be  content,  however,  with  finding 
merely  a  receipt  for  a  disbursement;  we  should  sat- 
isfy ourselves  that  the  total  amount  claimed  has  been 
disbursed  for  the  purposes  stated.  I  can  best  illus- 
trate this  by  calling  your  attention  to  the  case  of  an 
insurance  company  which  entrusted  the  settlement  of 
a  number  of  its  claims  to  an  adjuster,  giving  him  a 
certain  amount  of  cash  for  the  purpose;  it  subse- 
quently developed  that  it  was  the  practice  of  this  ad- 
juster to  take  a  receipt  from  the  claimant  with  the 
space  for  the  amount  paid  left  blank,  and  at  some  later 

[141] 


142        Examination  of  Insurance  Companies 

time  figures  were  inserted  which  enabled  the  adjuster 
to  make  a  handsome  profit  from  the  transactions. 

The  first  disbursements  shown  in  the  blank  relate  to 
the  payment  of  losses.  In  the  case  of  life  insurance 
companies,  the  losses  are  divided  into  three  groups  — 
death  losses,  matured  endowments  and  additions.  The 
third  division  arises  from  the  payment  of  the  addi- 
tional insurance  which  is  the  result  of  the  insured 
choosing  to  use  the  dividends  which  have  been  declared 
on  his  policy  for  the  purchase  of  paid-up  insurance 
instead  of  receiving  them  immediately  in  cash.  In 
examining  a  life  insurance  company,  you  will  satisfy 
yourself  that  not  only  has  the  proper  amount  been 
paid  on  each  policy,  but  also  that  the  proceeds  have 
been  paid  to  the  proper  person;  companies  require 
that  at  the  time  of  paying  a  claim  the  policy  shall  be 
deposited  with  the  company,  and  if  for  any  reason  the 
policy  be  absent,  a  satisfactory  explanation  should  be 
offered. 

In  the  case  of  annuities,  we  should  find  that  the 
company  has  in  its  possession  satisfactory  evidence 
that  the  annuitant  was  alive  at  the  time  that  the  pay- 
ment became  due. 

Should  the  policy  which  provides  for  the  payment 
of  its  proceeds  in  a  certain  number  of  installments, 
mature  as  a  death  claim  or  as  an  endowment,  the  com- 
muted value  of  the  installments  at  the  date  of  maturity, 
should  be  considered  as  a  disbursement,  and  the  dif- 
ference between  such  commuted  value  and  the  first 
actual  pa>Tnent  made  to  the  beneficiary,  should  be  car- 
ried into  the  income  portion  of  the  statement;  when 
the  subsequent  installments  are  paid  they  should  not 


Examination  of  Insueance  Companies        143 

be  included  among  the  losses,  and  we  find  a  separate 
item  in  the  disbursements  ''  paid  for  claims  on  supple- 
mentary contracts  not  involving  life  contingencies  " 
for  the  accommodation  of  such  payments. 

In  the  case  of  all  insurance  companies,  the  payments 
for  losses  are  stated  on  a  net  basis,  i.  e.,  the  amounts 
which  have  been  received  from  reinsuring  companies 
or  which  have  been  recovered  in  the  shape  of  salvage, 
are  deducted.  A  burglary  insurance  company,  for  in- 
stance, may  pay  a  loss  and  subsequently  recover  some 
of  the  stolen  articles;  the  amounts  which  it  realizes 
from  such  recoveries  are  to  be  deducted  from  any 
statement  of  losses  paid.  If  a  fire  insurance  company 
has  paid  a  loss  on  a  stock  of  merchandise  partially 
destroyed,  any  amount  which  it  receives  from  the  sale 
of  the  damaged  stock,  should  be  deducted  in  order  that 
the  net  amount  which  has  been  paid  to  claimants  may 
be  properly  shown. 

Life  insurance  companies  are  required  to  make 
returns  to  their  policyholders  in  two  other  ways 
besides  the  payment  of  losses  —  surrender  values  and 
dividends.  In  the  case  of  policies  surrendered  for 
cash,  we  should  find  the  policy  on  file  together  with  a 
receipt  showing  the  amount  paid,  and  a  release  from 
the  insured  and  the  beneficiary;  an  examiner  should 
satisfy  himself  that  surrender  values  have  been 
allowed  in  accordance  with  the  terms  of  the  policy 
contracts,  and  that  no  discrimination  has  been  per- 
mitted. Dividends  are  usually  authorized  by  the 
Board  of  Directors  of  the  company,  and  if  the  insured 
has  received  his  dividends  in  cash,  there  should  be  on 
file  some  evidence  of  the  pajonent.    Dividends  may  be 


144        Examination  of  Insurance  Companies 

paid  in  cash,  applied  to  the  payment  of  renewal 
premiums,  applied  to  shortening  the  endowment  or  the 
premium  paying  period,  used  for  the  purchase  of 
paid-up  additions  or  annuities,  or  may  be  left  with  the 
company  to  accumulate  at  interest;  if  the  last  named 
method  has  been  selected  by  the  insured,  it  devolves 
upon  the  examiner  to  see  that  a  proper  liability  is 
being  maintained  by  the  company  for  such  deposits. 

I  have  now  mentioned  practically  all  of  the  pay- 
ments which  are  made  by  insurance  companies  to  their 
policyholders,  and  will  now  briefly  refer  to  those  dis- 
bursements which  an  examiner  might  expect  to  find, 
and  which  are  not  self-explanatory. 

Paid  for  claims  on  supplementary  contracts  not  involv- 
ing life  contingencies 

This  is  the  item  to  which  I  have  previously  referred, 
and  my  object  in  bringing  it  to  your  attention  again  is 
to  point  out  that  the  payments  which  newly  established 
life  insurance  companies  make  to  the  holders  of  their 
Advisory  Board  or  Special  contracts  should  be  in- 
cluded here. 

Commissions  to  agents 

Companies  which  transact  other  than  a  life  insur- 
ance business  are  required  to  state  the  commissions 
or  brokerage  which  have  been  paid  to  their  agents 
(after  deducting  the  commissions  which  have  been 
repaid  to  them  on  return  premiums  and  reinsured 
policies)  but  are  not  required  to  separate  the  commis- 
sions on  first  year  premiums  from  the  commissions  on 


Examination"  of  Insurance  Companies        145 

the  renewal  premiums,  for  the  same  rate  is  allowed 
on  both  classes  of  premiums.  In  the  case  of  life  insur- 
ance companies,  however,  you  will  find  that  the  sepa- 
ration is  called  for,  owing  to  the  fact  that  the  initial 
cost  of  procuring  the  business  is  many  times  as  great 
as  the  renewal  commissions  which  are  paid  to  the 
agents;  for  statistical  purposes,  therefore,  it  is  im- 
portant that  we  should  be  able  to  separate  the  dis- 
bursements applicable  to  new  business  from  those 
items  of  disbursement  which  have  been  incurred  for 
the  renewal  of  the  business.  Your  attention  is  directed 
to  section  97  of  the  New  York  Insurance  Law  (see 
Appendix  0)  which  limits  the  amounts  which  may  be 
paid  for  the  expenses  of  the  first  year,  and  it  therefore 
becomes  important  for  us  to  be  able  to  separate  the 
commissions  in  the  case  of  a  company  to  which  this 
section  is  applicable. 

Commuted  renewal  commissions 

It  is  the  practice  of  some  companies  to  purchase 
from  a  retiring  agent  at  an  agreed  figure,  the  value  of 
future  renewals  which  will  have  to  be  paid  to  him 
under  his  contract;  if  these  payments  were  included 
with  the  other  renewal  commissions,  and  a  comparison 
made  with  the  renewal  premiums  collected,  it  would 
appear  that  an  unduly  large  percentage  had  been  dis- 
bursed and  we  therefore  have  this  separate  item.  An 
examiner  should  carefully  scrutinize  the  payments 
charged  to  this  account  in  order  that  the  general 
agency  methods  of  the  company  may  be  clearly  under- 
stood. 

10 


146        Examination  of  Insurance  Companies 

Compensation  of  managers  and  agents  not  paid  by 
commission  for  services  in  obtaining  new  insur- 
ance 

Agency  supervision  and  traveling  expenses  of  super- 
visors (except  compensation  for  home  office  super- 
vision) 

Branch  office  expenses,  including  salaries  of  managers 
and  clerks  not  included  in  Item  21 
Item  21  is  the  second  of  the  above  items,  and  the 

object  of  requiring  the  separation  of  disbursements  in 

this  way  is  for  statistical  and  statutory  purposes. 

Rent,  including  $ for  company's  occupancy  of 

its  own  buildings 
In  order  to  obtain  an  idea  of  the  true  earning  power 
of  a  piece  of  real  estate  owned  by  a  company,  it  is 
necessary  to  know  the  "  rental  earnings;"  by  this 
term  I  mean  the  sum  of  the  actual  rental  receipts  and 
an  allowance  for  any  occupancies,  for  which,  however, 
no  actual  rental  is  paid.  If,  for  instance,  a  company's 
Home  Office  should  occupy  a  certain  number  of  square 
feet,  it  is  but  just  in  estimating  the  rental  earning  of 
the  property  to  assme  that  the  company  is  paying  the 
same  rental  as  another  tenant  occupying  the  same 
space  would  pay.  It  will  be  equally  clear  to  you,  how- 
ever, that  the  application  of  this  theory  may  lead  to 
abuses,  for  it  would  be  a  simple  matter  to  inflate  the 
apparent  earning  power  of  a  piece  of  property  by 
assuming  the  receipt  of  rents  disproportionate  to  the 
space  occupied.  If,  therefore,  it  be  the  practice  of  a 
company  to  charge  itself  with  a  certain  amount  for  its 


Examination  of  Insurance  Companies        147 

own  rent  in  a  building  which  it  owns,  the  amount  so 
charged  should  be  indicated  in  this  item. 

Furniture,  fixtures  and  safes 

As  the  moneys  expended  for  these  purposes  are  not 
recognized  as  an  admissible  asset,  it  is  the  usual  prac- 
tice of  companies  to  consider  that  all  sums  expended 
for  these  purposes  are  disbursements  and  not  assets; 
it  merely  becomes  necessary  for  me,  therefore,  to  call 
your  attention  to  the  fact  that  the  account  of  furniture 
and  fixtures  should  not  appear  both  as  an  asset  and  as 
a  disbursement. 

Gross  decrease  by  adjustment,  in  book  value  of  ledger 
assets 

This  item  you  will  recognize  as  similar  to  the  one 
which  appeared  in  the  income  portion  of  the  state- 
ment, but  which  referred  to  the  increase  by  adjust- 
ment. We  should  find  here  all  items  which  as  a  result 
of  the  application  of  the  process  of  amortization  have 
decreased  the  book  value  of  the  bonds. 

We  should  also  find  here  the  amounts  which  have 
been  written  off  from  the  book  value  of  other  securities 
not  subject  to  amortization,  such  as  real  estate,  stocks, 
etc. 

Other  disbursements 

During  the  course  of  the  year  the  company  may  have 
some  items  of  disbursements  which  cannot  be  con- 
veniently referred  to  any  of  the  items  appearing  in 
the  annual  statement  blank,  and  it  is  for  the  accommo- 
dation of  them  that  this  flexible  item  has  been  created. 


148        Examination  of  Insurance  Companies 

All  items  of  profit  and  loss,  other  than  those  covered 
by  the  regular  items,  will  appear  here,  and  it  is  but 
proper  that  I  should  bring  to  your  attention  the  neces- 
sity for  the  careful  examination  of  all  profit  and  loss 
entries.  I  know  of  no  more  fertile  field  for  the  growth 
of  improper  practices  than  the  profit  and  loss  account 
in  a  company's  system  of  accounts. 


CHAPTER  XVIII 

Schedules  —  Development  of  Schedules  in  Annual 
Statement  Blanks  —  Analysis  and  Explanation  of 
Schedules  A  to  Y,  Inclusive  of  Life  Blank 

I  have  determined  this  morning  to  speak  to  you 
about  the  schedules  which  appear  in  the  annual  state- 
ment blanks  and  which  contain  valuable  information 
for  the  examiner.  Their  importance  justifies  me  in 
devoting  some  time  to  their  consideration. 

Schedules,  like  many  other  matters  connected  with 
insurance  supervision,  have  been  largely  a  matter  of 
development.  Until  five  or  six  years  ago,  the  sched- 
ules in  the  annual  statements  which  Insurance  Depart- 
ments required  companies  to  file  with  them  were 
rather  primitive  and  were  intended  merely  to  list 
certain  assets  of  the  company.  They  were  four  in 
number;  a  schedule  showing  the  real  estate  owned  by 
the  company  at  the  close  of  business  December  31st  of 
the  year  for  which  the  statement  was  rendered,  one 
showing  the  bonds  and  stocks  owned  at  that  time,  one 
containing  information  about  the  collateral  loans  out- 
standing on  December  31st  and,  finally,  one  containing 
information  about  the  mortgage  loans.  This  was  the 
extent  of  the  schedule  requirements. 

By  reference  to  the  annual  statement  blank  in  use 
at  the  present  time,  you  will  see  that  a  great  many 
more  schedules  are  required  from  the  companies  and 
the  additional  requirements  may  be  divided  into  two 

[149] 


150        Examination  of  Insurance  Companies 

parts:  first,  those  schedules  which  will  enable  the 
supervising  official  to  verify  some  of  the  more  impor- 
tant items  of  liabilities  and,  second,  the  schedules  per- 
taining solely  to  methods  of  management,  details  of 
administration  and  facts  not  connected  in  any  way 
with  the  financial  solvency  or  insolvency  of  the  com- 
pany. 

Considering  for  the  present  the  statement  which  life 
insurance  companies  are  required  to  file  with  the  New 
York  Department,  you  will  find  that  Schedule  A  is 
now  divided  into  three  parts,  the  first  listing  all  the 
real  estate  owned  at  the  time  of  making  the  statement 
and  giving  a  great  number  of  details,  such  as  the 
original  cost,  the  book  value,  the  earnings,  the  expenses 
and  other  matters  pertaining  to  each  item;  the  second 
part  of  the  schedule  deals  with  the  real  estate  parcels 
which  have  been  acquired  during  the  year  to  which 
the  statement  applies,  the  object  of  this  additional 
information  being  to  develop  the  method  by  which 
the  real  estate  was  acquired  (by  purchase  or  fore- 
closure) and  from  whom  it  was  acquired,  in  order  to 
indicate  whether  any  improper  factors  have  entered 
into  its  purchase  or  whether  the  foreclosures  indicated 
that  lax  methods  prevailed  when  the  mortgage  loans 
were  made;  the  third  part  of  the  schedule  relates  to 
the  real  estate  which  has  been  sold  during  the  year 
and  is  intended  to  develop  not  only  any  loss  or  profit 
which  the  company  may  have  realized  from  each  sale, 
but  also  the  name  of  the  purchaser,  in  order,  as  I 
pointed  out  when  dealing  with  the  second  part  of  this 
schedule,  to  determine  whether  any  improper  motives 
have  entered  into  the  sales.  In  addition  to  these  three 
parts  there  is  also  a  classification,  intended  solely  for 


Examination  of  Insurance  Companies        151 

statistical  purposes,  which  shows  the  way  in  which 
the  real  estate  is  geographically  divided,  apportioning 
the  various  holdings  between  the  different  States  and 
countries. 

Schedule  B,  while  retaining  practically  the  same 
form  that  it  has  had  for  a  number  of  years,  now 
shows  not  only  the  mortgages  which  are  owned  by  the 
company  at  the  time  that  the  statement  was  made, 
but  also  includes  a  statement  of  the  acquisitions,  in- 
creases, reductions  and  those  mortgages  which  have 
been  disposed  of.  A  classification  similar  to  the  one 
indicated  in  Schedule  A  is  also  found  here. 

Schedule  C  is  the  one  relating  to  collateral  loans  and 
is  one  of  the  most  important  schedules  in  the  blank. 
It,  like  Schedule  A,  is  divided  into  three  parts,  the  first 
showing  all  collateral  loans  outstanding  at  the  time 
the  statement  was  made,  the  second  showing  the  loans 
which  were  made  during  the  year,  and  the  third  list- 
ing the  loans  which  were  discharged  in  whole  or  in 
part  during  the  year.  In  former  years,  the  only  sched- 
ule relating  to  collateral  loans  which  was  required  of 
companies  was  one  similar  to  the  first  part  of  the 
present  schedule,  but  even  this  part  in  the  present 
schedule  is  very  much  amplified  and  requires  the  filing 
of  such  additional  information  as  a  detailed  statement 
of  the  collateral  which  has  been  released  and  the  sub- 
stitutions which  have  been  made,  if  any.  The  name 
of  the  actual  borrower  is  likewise  insisted  upon,  and 
the  use  of  these  three  subdivisions  during  successive 
years  will  enable  a  supervising  ofiicial  to  determine 
whether  any  '*  window  dressing  "  has  been  indulged 
in;  in  other  words,  whether  on  December  31st  of  one 
vear  loans  were  ostensibly  paid  off  and  remade  on 


152        Examination  of  Insurance  Companies 

January  1st  of  the  next  year.  This  you  will  recall 
was  one  of  the  evils  which  was  developed  by  the  recent 
investigation. 

Schedule  D,  relating  to  bonds  and  stocks,  is  divided 
into  four  parts,  the  first  showing  all  bonds  owned  by 
the  company  on  December  31st,  the  second  showing 
the  stocks  owned,  the  third  showing  the  bonds  and 
stocks  acquired  during  the  year,  and  the  fourth  show- 
ing the  bonds  and  stocks  sold,  redeemed  or  otherwise 
disposed  of  during  the  year.  In  the  past  the  first  and 
second  parts  alone  were  required,  but  the  present  form 
of  these  parts  indicates  great  enlargement,  and  we 
now  have  columns  which  develop  whether  there  has 
been  any  increase  or  decrease  by  adjustment  in  the 
book  values  during  the  year.  In  addition  to  this  infor- 
mation, companies  reporting  to  the  New  York  Depart- 
ment are  required  to  furnish  additional  information 
which  will  enable  the  Department  to  judge  of  the 
methods  of  amortization  used  by  the  company.  The 
object  of  requiring  the  names  of  the  purchasers  and 
the  names  of  the  vendors  in  the  third  and  fourth  parts 
of  this  schedule  is  to  furnish  the  Department  with  full 
information  relative  to  these  details. 

Schedule  E  is  one  which  shows  the  bank  balances 
which  were  outstanding  on  December  31st  of  the  state- 
ment year,  and  in  addition  thereto  contains  columns 
for  each  month  in  order  that  the  company  may  show 
the  largest  balance  which  existed  during  those  months 
in  each  of  the  banking  institutions.  There  is  likewise 
a  column  showing  the  amount  of  interest  received  dur- 
ing the  year  on  these  balances,  and  it  is  hardly  neces- 
sary for  me  to  devote  much  time  to  an  explanation  of 
the  object  of  this  schedule.      I  may  say  briefly  that 


Examination  of  Insurance  Companies        153 

it  is  intended  to  develop  whether  the  company  is  per- 
mitting an  abnormal  amount  of  its  assets  to  take  th'e 
form  of  cash  in  bank,  whether  any  of  the  banking 
institutions  are  being  favored  at  the  expense  of  the 
policyholders  owing  to  the  connection  with  such  insti- 
tution of  any  of  the  company's  officers  or  directors, 
and  whether  any  of  the  banks  are  being  used  as  an 
adjunct  to  any  of  its  other  financial  operations.  This 
schedule  is  the  first  of  what  I.  may  term  the  new  series, 
the  first  four  constituting  the  original  schedules  which 
were  formerly  required  by  Insurance  Departments. 

Schedule  F  shows  the  claims  for  death  losses  and 
for  other  policy  claims  resisted  or  compromised  during 
the  year,  and  also  shows  all  policy  claims  which  were 
resisted  and  unpaid  at  the  end  of  the  year  covered  by 
the  statement. 

Schedule  G  shows  all  salaries,  compensation  and 
emoluments  received  during  the  year  by  the  officers 
and  directors,  and  also  the  amounts  received  by  any 
other  person,  firm  or  corporation  when  such  payments 
were  in  excess  of  $5,000;  this  schedule  is  intended  to 
enable  the  Department  to  ascertain  whether  there 
have  been  any  improper  disbursements  and  also 
enables  it  to  ascertain  by  whom  the  disbursements 
have  been  authorized. 

Section  103  of  the  New  York  Insurance  Law  (see 
Appendix  P)  sets  forth  the  information  which  must 
be  furnished  to  the  Insurance  Department  and  some 
of  the  foregoing  information  as  well  as  the  facts  which 
some  of  the  subsequent  schedules  are  intended  to  de- 
velop have  been  inserted  in  compliance  with  that  sec- 
tion. Schedule  H,  for  instance,  which  is  intended  to 
show  the  payments  for  agency  supervision,  is  of  this 


154        Examination  of  Insubance  Companies 

nature  and  is  for  the  purpose  of  ascertaining  whether 
the  company  is  complying  with  those  statutes  limiting 
the  amount  which  may  be  expended  for  procurement 
purposes. 

Schedule  I,  showing  all  commissions  paid  on  loans 
or  on  the  purchase  or  sale  of  any  property  during  the 
year,  is  self-explanatory,  and  the  purposes  of  this  in- 
formation will  require  no  further  explanation  upon 
my  part. 

Schedule  J  pertains  to  the  legal  expenses;  it  must 
be  apparent  to  you  that  a  Department  is  interested  in 
knowing  whether  the  companies  under  its  supervision 
are  litigious  or  are  settling  their  just  claims  without 
requiring  their  claimants  to  resort  to  law.  In  the 
past  some  improper  disbursements  have  been  hidden 
under  the  guise  of  "  legal  expenses  "  and  the  object 
of  this  schedule  is  to  prevent  the  repetition  of  such 
conditions. 

Schedule  K,  showing  the  expenditures  in  connection 
with  matters  before  legislative  bodies,  officers  or  any 
branch  of  the  government,  is  intended  to  develop 
whether  the  company  has  paid  anything  for  the  pur- 
pose of  securing  or  defeating  legislation,  to  whom  such 
payments  have  been  made,  if  any,  and  also  whether 
any  contributions  have  been  made  to  campaign  funds. 

Schedule  L  shows  the  proceedings  of  the  last  annual 
election  of  the  corporation,  the  names  of  the  candi- 
dates for  directors  or  trustees  or  any  corresponding 
office,  the  number  of  votes  cast  for  each  candidate  and 
whether  the  votes  were  presented  in  person,  by  proxy 
or  by  mail.  The  object  of  this  schedule  is  for  the  pur- 
pose of  ascertaining  how  thoroughly  the  members  of 
the  corporation  or  the  policyholders  enter  into  the 


Examination  op  Insurance  Companies        155 

active  management  of  affairs  and  how  vitally  inter- 
ested they  were  in  the  election  of  directors.  The  abuse 
of  proxy  voting  will  likewise  be  indicated  by  this 
schedule. 

Schedule  M  is  intended  to  develop  facts  relating  to 
the  payment  of  annual  dividends  and  to  enable  the 
Insurance  Department  to  observe  how  these  have  been 
running  for  a  number  of  years  in  comparison  with  the 
premiums  which  have  been  charged.  For  this  pur- 
pose the  schedule  is  divided  first  into  four  parts,  giv- 
ing the  facts  relating  to  the  typical  ages,  25,  35,  45 
and  55.  Each  one  of  these  four  parts  is  so  subdivided 
as  to  indicate  the  premiums  and  dividends  which  have 
been  paid  during  the  nineteen  years  which  immedi- 
ately precede  the  statement  year  upon  the  various 
kinds  of  policies  which  have  been  issued.  The  sched- 
ule, therefore,  contains  a  record  of  the  annual  divi- 
dends which  have  been  paid  in  each  of  the  past  nine- 
teen years  on  the  various  forms  of  policies  issued  at 
these  typical  ages,  and  in  this  way  it  is  very  easy  to 
make  comparisons  between  the  various  plans,  between 
the  various  forms  and  to  ascertain  whether  any  glar- 
ing injustice  has  been  done. 

Schedule  N  relates  to  the  payments  which  have  been 
made  during  the  year  on  deferred  dividend  policies 
and  the  premiums  charged  (Schedule  M  dealing  with 
annual  dividend  policies  only)  and  uses  the  same 
typical  ages  and  the  same  forms  of  insurance  as  does 
Schedule  M,  but  instead  of  referring  the  policies  to 
the  year  of  issue,  uses  dividend  periods  for  the  pur- 
pose of  ascertaining  the  relative  returns.  The  infor- 
mation for  policies  using  a  five-year  distribution 
period,  is  required  for  each  of  the  past  five  periods: 


156        Examination  of  Insurance  Companies 

a  five-year  distribution  policy,  therefore,  issued  at  age 
25  and  which  has  been  in  force  for  twenty-five  years, 
will  show  the  amounts  received  upon  it  at  the  end  of 
each  of  the  five  periods;  the  10,  15,  20,  25  and  30-year 
distribution  periods  are  not  so  subdivided,  the  blank 
contenting  itself  with  one  distribution  only. 

Schedule  0  shows  the  amounts  which  have  been  set 
apart,  provisionally  ascertained,  calculated  or  held 
awaiting  apportionment  on  policies  with  deferred  divi- 
dend periods  longer  than  one  year,  together  with  the 
annual  premiums  charged  for  the  insurance.  The 
same  arrangement  of  ages  and  forms  of  insurance  is 
used  in  this  schedule  as  in  Schedule  N.  Schedule  N 
refers  to  the  deferred  dividends  which  were  paid  dur- 
ing the  year;  Schedule  0  refers  to  the  amounts  which 
have  been  set  apart  for  future  payments.  The  infor- 
mation given  by  this  schedule  on  five-year  deferred 
dividend  policies,  for  instance,  enables  a  Department 
to  ascertain  how  much  was  set  aside  on  an  ordinary 
life  policy  issued  at  age  25  in  each  of  the  years  1905 
to  1909,  inclusive;  similar  subdivisions  are  made  for 
the  other  dividend  periods. 

Schedule  P  is  in  reality  a  summary  of  Schedule  0, 
in  that  it  shows  the  total  amount  set  apart  on  all  the 
deferred  dividend  policies,  while  Schedule  0,  you  will 
recall,  refers  only  to  the  four  typical  ages. 

Schedule  X  deals  with  the  unlisted  assets  of  a  com- 
pany which  do  not  appear  in  any  of  its  schedules 
showing  the  property  owned  at  the  time  of  the  state- 
ment was  made.  It  must  be  apparent  to  you  that  if 
a  security,  take  for  instance,  a  share  of  stock,  is  con- 
sidered valueless  and  is  charged  to  profit  and  loss,  it 
disappears  from  the  financial  books  and  records  of  the 
company.     In  subsequent  years  the  value  of  that  stock 


Examination  of  Insurance  Companies        157 

may  be  re-established  and  if  no  record  be  kept  it  could 
be  sold  and  its  proceeds  diverted  into  improper  chan- 
nels. By  means  of  Schedule  X,  the  property  owned 
by  the  company  but  not  included  in  its  annual  finan- 
cial statement,  is  set  forth  and  by  comparing  Sched- 
ule X  of  one  year's  statement  with  the  corresponding 
schedule  of  the  previous  year,  it  can  at  once  be  deter- 
mined whether  any  particular  item  has  disappeared, 
and  if  so  whether  proper  credit  has  been  given  the 
corporation  for  it. 

Schedule  Y  is  divided  into  two  parts,  the  first  relat- 
ing to  purchases  which  have  been  made  during  the 
year  and  which  have  not  been  shown  in  Schedules  A, 
B,  C  and  D  and  in  the  furniture,  fixture  and  supply 
accounts.  The  second  part  relates  to  property  sold 
during  the  year,  except  that  shown  in  Schedules  A,  B, 
C  and  D.  Primarily  the  object  of  inserting  this  sched- 
ule is  to  comply  with  section  103  of  the  Insurance 
Law.  I  can  easily  appreciate,  however,  that  the  first 
part  might  be  used  for  the  purpose  of  determining 
whether  the  company  has  invested  any  of  its  funds  in 
securities  unauthorized  by  the  Insurance  Law. 


CHAPTER  XIX 

Additional  Schedule  for  Fraternals  —  Schedules  in 
Blank  Used  by  Fidelity,  Surety,  Credit  and  Lia- 
bility Companies  —  Detailed  Classification  of  Fidel- 
ity and  Surety  Risks. 

In  my  talk  the  other  morning  T  took  for  my  subject 
the  schedules  which  appear  in  the  annual  statement 
blank  which  life  insurance  companies  reporting  to  the 
Insurance  Department  of  the  State  of  New  York,  are 
required  to  file.  The  blank  which  fraternal  organiza- 
tions are  required  to  use,  while  not  as  elaborate  as  that 
required  from  legal  reserve  life  insurance  companies, 
contains  one  schedule  which  we  do  not  find  in  the 
other  blank  —  the  schedule  of  membership,  showing 
the  number  of  members  at  the  time  the  annual  state- 
ment was  made,  the  amount  of  insurance,  the  amount 
received  in  mortuary  assessments  during  the  year  and 
the  number  and  amount  of  death  losses  incurred  dur- 
ing the  year,  all  arranged  according  to  the  attained 
age  of  the  membership.  This  schedule  is  of  particular 
use  only  when  the  members  of  the  fraternals  have 
yearly  renewable  term  insurance,  for  if  used  by  an 
Order,  the  premiums  of  which  are  calculated  upon  a 
correct,  scientific  basis,  there  will  be  no  relation 
between  the  assessments  collected  and  the  claims  in- 
curred at  the  attained  ages.  To  illustrate:  a  member 
who  was  49  years  of  age  when  he  entered  a  year  ago, 
has  now  the  same  attained  age  as  the  member  who  was 

[1&8] 


Examination  of  Insurance  Companies        159 

40  when  he  went  in  ten  years  ago.  In  consequence 
their  mortuary  assessments  are,  or  should  be,  entirely 
different,  and  without  the  data  necessary  to  calculate 
the  funds  which  should  be  on  hand  for  the  protection 
of  the  second  member,  the  figures  given  are  valueless 
and  meaningless. 

An  inspection  of  the  forms  required  from  companies 
transacting  other  forms  of  business,  indicates  that 
with  the  exception  of  fidelity,  surety,  credit  and  lia- 
bility companies,  no  special  schedules  requiring  our 
attention  are  required.  Eeferring  then  to  the  blank 
which  miscellaneous  stock  companies  are  required  to 
file,  we  find  that  it  contains  similar  schedules  to  the 
ones  in  the  life  blank,  referring  to  the  five  principal 
forms  of  assets  only  —  real  estate,  mortgages,  collat- 
eral loans,  bonds  and  stocks;  Schedule  D,  however,  the 
one  relating  to  the  bonds  owned  by  the  company,  is 
not  quite  as  elaborate  as  in  the  case  of  life  insurance 
companies,  for  we  find  none  of  the  columns  pertaining 
to  amortization. 

The  first  schedule  which  requires  our  attention  is 
Schedule  H  (the  schedules  in  the  blank  are  not  ar- 
ranged alphabetically  and  I  shall  take  them  up  in  the 
order  in  which  they  appear  in  the  printed  form),  con- 
taining a  statement  of  the  salvage  received  during  the 
year  on  account  of  losses  and  claims  paid  prior  to  the 
close  of  the  year  covered  by  the  statement.  There  is 
nothing  of  special  importance  to  which  I  need  direct 
your  attention  in  this  schedule;  its  headings  are  self- 
explanatory  and  my  only  object  in  referring  to  it  is 
to  point  out  that  it  is  an  indication  of  the  growing 
desire  upon  the  part  of  supervising  officials  to  ascer- 
tain the  exact  nature  of  every  item  entering  into  the 
annual  statement. 


160        Examination  of  Insurance  Companies 

Schedule  G  relates  to  fidelity,  surety  and  credit 
losses  and  claims  only;  its  object  is  to  ascertain  how 
much  has  been  paid  in  each  of  the  past  ten  years  on 
claims  which  remained  unpaid  on  December  31st  of 
the  various  years.  A  specific  case  will  make  this 
clearer.  If  on  December  31,  1900,  there  were  claims 
on  fifty  fidelity  policies  unpaid,  the  blank  calls  for  the 
payments  which  have  been  made  on  account  of  those 
fifty  claims  in  1901,  1902,  1903,  etc.,  up  to  and  includ- 
ing 1910,  and  if  any  of  these  fifty  claims  remained 
unpaid  on  December  31,  1910,  the  company  is  required 
to  state  what  liability  it  is  carrying  on  account  of  such 
claims  in  the  1910  annual  statement.  By  its  use,  the 
supervising  official  is  enabled  to  ascertain  whether  the 
amounts  carried  in  the  annual  statement  for  the  vari- 
ous years  as  representing  the  liability  on  unpaid  claims 
is  approximately  correct,  or  whether  the  company  has 
uniformly  adopted  a  system  of  under-estimating  its 
liabilities.  The  unpaid  losses  for  each  of  the  past  ten 
years  are  arranged  on  the  lefthand  side  of  this  sched- 
ule and  the  payments  during  the  various  years  are 
arranged  on  horizontal  lines  so  that  the  payments  of 
each  year  are  referred  to  each  of  the  outstandings. 
In  order  to  prevent  confusion,  I  desire  to  call  your 
attention  to  the  fact  that  the  years  indicated  on  the 
lefthand  side  of  this  schedule  are  not  years  of  issue, 
but  refer  to  the  outstanding  losses  on  December  31st 
of  the  various  years.  A  loss,  therefore,  which  was 
outstanding  on  December  31,  1900,  and  not  settled 
until  some  time  in  1903,  would  appear  in  each  of  the 
1900,  1901  and  1902  totals. 

Schedule  0  is  divided  into  two  parts.  Part  1  refers 
to  the  following  forms  of  insurance: 


Examination  of  Insurance  Companies        161 

1.  Accident. 

2.  Health. 

3.  Fidelity. 

4.  Surety. 

5.  Plate  Glass. 

6.  Steam  Boiler. 

7.  Burglary  and  Theft. 

8.  Credit. 

9.  Sprinkler. 

10.  Title. 

11.  Fly  Wheel. 

12.  Auto  Property  Damage. 

13.  Workmen's  Collective. 

14.  Live  Stock. 

The  information  which  it  sets  forth  shows  the  man- 
ner of  arriving  at  the  items  of  *'  net  unpaid  claims 
except  liability  claims  "  and  ''  special  reserve  for 
credit  losses  on  policies  expiring  in  October,  November 
and  December  "  contained  in  the  liability  portion  of 
the  statement.  For  the  purposes  of  this  schedule, 
losses  are  divided  into  two  parts:  first,  those  which 
were  outstanding  December  31st  of  the  previous  year 
and,  second,  those  which  were  incurred  during  the 
year  of  the  statement  and  which  remained  unpaid  on 
December  31st  of  that  year.  The  second  column  of 
this  schedule  shows  the  increase  or  decrease  which 
was  made  in  the  estimated  liability  as  it  stood  Decem- 
ber 31st  of  the  previous  year.  This  column,  taken  in 
conjunction  with  the  payments  which  were  made  on 
account  of  such  claims  during  the  current  year  and 
the  amount  which  is  being  carried  as  a  liability  for 
those  still  remaining  unpaid,  furnishes  an  excellent 
index  of  the  estimating  ability  of  the  underwriters  of 
the  companies  who  have  in  charge  the  fixing  of  an 
11 


162        Examination  of  Insurance  Companies 

adequate  liability  for  unpaid  losses;  in  fact,  the  object 
of  Schedules  G,  0  (Parts  1  and  2),  J,  K  and  M,  is  the 
verification  of  this  important  item  of  liability  by  the 
old  test  of  proving  the  value  of  the  pudding  by; 
eating  it. 

You  will  note  that  liability  claims  have  been  omitted 
from  Part  1  of  Schedule  0,  and  Part  2  of  that  schedule 
is  devoted  to  liability  claims  only.  It  separates  the 
unpaid  losses  into  three  groups  (and  in  order  to  make 
the  subdivisions  clearer,  I  shall  use  the  figures  con- 
tained in  the  statement  upon  which  the  companies  will 
report  their  operations  for  1910) ;  first,  those  issued 
prior  to  1900,  second,  those  issued  between  1901  and 
1905,  inclusive,  and  third,  those  issued  between  1906 
and  1910,  inclusive.  The  issues  of  each  year  are  kept 
separate  and  the  final  objects  of  the  schedule  may  be 
stated  as  an  attempt  to  find  the  ratio  which  exists 
between  the  earned  premiums  on  the  one  hand  and  the 
loss  payments,  plus  the  statutory  reserve,  on  the  other. 
The  fact  that  this  schedule  contains  a  column  headed 
' '  additional  liability  for  unpaid  losses  and  claims  and 
expenses  of  settlement  as  computed  by  the  company," 
is  a  tacit  admission  that  the  statutory  method  of  com- 
puting the  value  of  unpaid  liability  losses  in  New 
York  State  is  insufficient. 

Schedule  J  refers  only  to  fidelity  and  surety  losses 
or  claims  which  were  unpaid  on  January  1st  of  the 
year  covered  by  the  statement;  it  does  not  take  into 
account  the  year  in  which  the  loss  occurred  or  the  year 
in  which  the  policy  was  issued.  Using  again  the  1910 
statement  as  a  basis,  a  company  would  be  required  to 
include  in  Schedule  J  all  of  the  losses  which  were  out- 
standing  on   December  31,   1909.     Claims   are  here 


Examination  of  Insurance  Companies        163 

arranged  consecutively  by  claim  number,  so  that  they 
may  be  easily  followed  from  statement  to  statement, 
and  you  will  notice  that  the  arrangement  of  the  col- 
umns is  such  as  to  bring  in  close  proximity,  the  pay- 
ments which  were  made  during  1910  with  the  esti- 
mated value  of  the  loss  on  December  31,  1909,  or  if  no 
payment  was  made  during  1910,  then  the  amount  of 
the  estimated  liability  on  December  31,  1910,  is  shown. 
If  a  company  honestly  tabulate  all  of  its  outstanding 
claims.  Schedules  J  and  K  furnish  an  absolute  index 
to  the  sufficiency  or  insufficiency  of  its  loss  reserve. 

Schedule  K  is  similar  to  J,  but  refers  to  those  fidelity 
and  surety  losses  or  claims  of  which  the  company 
received  notice  during  1910  and  which  remained 
unpaid  at  the  close  of  business  December  31,  1910.  I 
need  not  devote  much  attention  to  this  schedule,  and 
I  merely  desire  to  call  your  attention  to  the  fact  that 
the  losses  which  this  year  are  scheduled  in  K  will 
appear  in  J  next  year,  whether  they  were  settled 
during  1911  or  not. 

Like  J  and  K,  Schedule  M  applies  only  to  fidelity 
and  surety  risks.  An  attempt  here  has  been  made  to 
classify  the  different  forms  of  policies  and  bonds 
referring  to  the  fidelity  and  surety  business.  You  will 
recall  that  in  a  previous  talk  I  attempted  to  distin- 
guish between  a  fidelity  and  a  surety  risk,  and  in  order 
to  supplement  that  distinction,  I  shall  here  read  the 
detailed  classification  of  risks  required  by  the  Insur- 
ance Departments  from  companies  preparing  their  data 
for  Schedule  M.  This  classification  was  arrived  at 
after  conferences  between  underwriters  and  repre- 
sentatives from  the  Insurance  Departments,  and  is 
brought  to  your   attention   as   constituting   the  best 


164        Examination  of  Insurance  Companies 


available  classification  which  we  have  been  able  to 
obtain  without  making  the  details  too  cumbersome  for 
practical  use. 

Class  No.  1.  Fidelity.—  Executives,  Agents,  Clerks, 
etc.,  of  Financial  Institutions,  Public 
Service  Corporations,  Mercantile, 
Manufacturing,  Fraternal,  Labor 
Organizations,  et  al. 

Class  No.  2.  Fiduciary. — Administrators,  Executors, 
Guardians,  Trustees,  Assignees,  Re- 
ceivers, Committees,  Conservators, 
Curators. 

Class  No.  3.  Public  Officials. —  State,  County,  Mu- 
nicipal Officials,  Accounting  Officers, 
Judges,  Court  Clerks,  Notaries,  Po- 
licemen, et  al. 

Class  No.  4.  U.  S.  Gov't  Officials. —  Includes  every 
risk  covering  any  official  or  employee 
running  to  the  U.  S.  Government. 

Class  No.  5.  Customs  —  Internal  Revenue. —  In- 
cludes all  bonds  given  to  the  Customs 
or  Internal  Revenue  Department  of 
the  U.  S.  Government  and  other 
financial  guarantee  running  to  the 
Federal  Government. 

Class  No.  6.  Contract  —  U.  S.  Government. —  Con- 
struction, Furnishing  of  Supplies. 

Class  No.  7.  Contract  —  General. —  Construction, 
Furnishing  of  Supplies,  All  Con- 
tractor Risks  other  than  running  to 
the  Federal  Government. 

Class  No.  8.  Judicial  or  Court. —  Refunding,  Appeal, 
Bail,  Attachment,  Costs,  Replevin, 
etc.  All  bonds  required  in  or  termi- 
nated by  a  judicial  proceeding. 

Class  No.     9.    Depository. 

Class  No.  10.    License  —  Franchise, 


Examination  of  Insueance  Companies         165 

Class  No.  11.   Excise. 

Class  No.  12.  Indemnity  —  Miscellaneous. —  Includes 
all  financial  guarantees  not  reported 
in  classes  7  to  11,  inclusive,  guar- 
anteeing payment  of  rents,  lost  se- 
curities, etc. 

Schedule  M  is,  in  reality,  divided  into  four  parts  as 
follows : 

Experience  of  1909  on  business  written  in  1909. 
Experience  of  1910  on  business  written  in  1909. 
Experience  of  1910  on  business  written  in  1910. 
Experience  of  1911  on  business  written  in  1910. 

It  is  manifestly  impossible  to  fill  in  tbe  figures  for 
the  last  of  the  four  subdivisions,  as  the  statement  con- 
taining this  schedule  will  have  to  be  filed  during  Janu- 
ary or  February  of  1911;  the  object  of  giving  this 
fourth  part  is  to  give  timely  warning  to  the  company 
of  the  future  requirements.  Concerning  this  exhibit 
the  blank  states : 

'*  It  is  proposed  to  extend  this  schedule  to  show 
each  year's  experience  on  the  business  written  in 
1909  and  subsequent  years  until  such  business  has 
been  terminated,  and  all  claims  thereunder  set- 
tled." 

The  distinguishing  feature  of  this  schedule  is  that 
it  disregards  entirely  the  premiums  which  have  been 
charged  by  the  companies  and  attempts  to  make  all 
of  its  comparisons  with  the  gross  penalty  written  in 
the  bond  or  policy.  It  is  an  attempt  to  derive  some 
method  of  computing  the  present  value  of  future  loss 
payments  on  the  basis  of  the  face  of  the  bond  or  policy 


166        Examination  of  Insueance  Companies 

—  ''face"  here  being  used  as  synonymous  with 
**  penalty."  Some  underwriters  have  declared  that  no 
such  determination  can  be  made,  and  statisticians  con- 
nected with  Insurance  Departments  and  insurance 
companies  will  watch  the  figures  developed  in  Schedule 
M  with  a  great  deal  of  interest. 

Schedule  N,  referring  to  the  bank  balances  carried 
in  each  banking  institution,  and  Schedule  X,  relating 
to  the  unlisted  assets,  are  similar  to  the  corresponding 
schedules  in  the  life  blank,  and  need  no  further 
explanation  upon  my  part. 

Schedule  P  exhibits  the  details  of  the  calculation 
made  in  accordance  with  Section  86  of  the  New  York 
Insurance  Law,  and  applies  only  to  companies  trans- 
acting a  liability  business.  Section  86,  you  will  recall, 
deals  with  the  present  value  of  future  liability  loss 
payments.  It  is  now  generally  admitted  by  under- 
writers that  this  method  laid  down  by  the  statute, 
yields  too  low  a  reserve,  and  well-managed  companies 
do  not  rely  solely  upon  its  provisions  when  stating 
their  liabilities,  but  carry  an  additional  voluntary  re- 
serve to  cover  the  payments  which  they  feel  will  have 
to  be  made  in  the  future.  In  connection  with  this  I 
desire  to  recall  to  your  mind  the  paper  dealing  with 
the  question  of  liability  loss  reserves  (see  Appen- 
dix L). 


CHAPTER  XX 

Schedules  and  Their  Application  to  Financial  Portions 
of  Statement  —  Method  of  Checking  Details  Shown 
in  Schedules  with  Items  in  Other  Portions  of  State- 
ment. 

In  my  previous  talks  I  outlined  briefly  the  forms 
which  the  schedules  in  the  life  and  the  miscellaneous 
blanks  have  taken,  outlined  in  a  general  way  the 
reason  for  asking  for  the  information  therein  con- 
tained, and  indicated  that  the  schedules  showed  the 
increased  interest  which  supervising  officials  were  tak- 
ing in  the  operations  of  the  companies  reporting  to 
them.  I  desire  in  a  very  brief  manner  to  call  your 
attention  to  certain  uses  to  which  the  schedules  may 
be  put  in  the  way  of  ascertaining  the  correctness  of 
the  income,  the  disbursement,  the  asset  and  the  lia- 
bility portions  of  the  financial  part  of  the  annual  state- 
ment blank.  An  observance  of  these  rules  will  enable 
companies  to  prepare  their  annual  statement  blanks 
in  such  a  way  as  to  render  unnecessary  a  great  part 
of  the  correspondence  which  now  finds  its  way  into 
the  offices  of  the  Insurance  Commissioners  of  the 
various  States. 

In  order  that  we  may  have  a  definite  basis  upon 
which  to  go,  I  shall  refer  to  the  blanks  used  by  the 
New  York  Insurance  Department  for  the  purpose  of 
having  companies  report  their  condition  as  of  Decem- 
ber 31,  1910. 

[167] 


168        Examination  of  Insurance  Companies 

LITE  BLANK 
Schedule  A  —  Part  1 

The  total  of  the  ' '  book  value  ' '  column  should  agree 
with  item  1  of  assets,  ''  book  value  of  real  estate." 

The  *'  market  value  "  column  should  be  used  as  a 
basis  for  item  22  of  assets,  "  market  value  of  real 
estate  over  book  value,"  or  part  of  item  42  of  assets, 
*'  book  value  of  ledger  assets  over  market  value." 
Should  the  market  value  of  the  real  estate  owned  be 
in  excess  of  the  book  value,  the  difference  will  be  car- 
ried in  item  22,  while  if  there  be  a  depreciation  the 
loss  will  be  carried  under  item  42. 

The  total  of  the  ^'  increase,  by  adjustment,  in  book 
value  during  1910  "  column,  when  added  to  the  total 
in  a  similar  column  in  part  3  of  this  schedule,  should 
be  the  same  as  item  42(a)  of  income,  "  gross  increase, 
by  adjustment,  in  book  value  of  real  estate. ' ' 

The  total  of  the  "  decrease,  by  adjustment,  in  book 
value  during  1910  "  column,  when  added  to  the  total 
in  a  similar  column  in  part  3  of  this  schedule,  should 
be  the  same  as  item  47(a)  of  disbursements,  "  gross 
decrease,  by  adjustment,  in  book  value  of  real  estate." 

You  will  find  that  this  schedule  contains  an  exhibit 
of  the  gross  rental  and  expenditure  for  taxes,  repairs 
and  expenses  of  each  parcel  for  each  of  the  last  three 
years.  The  total  of  the  "  gross  rental  during  1910  " 
column,  when  added  to  the  total  of  the  '^  gross  rental 
during  1910  "  column  of  part  3,  should  equal  item  32 
of  income,  ''  gross  rent  from  company's  property." 

The  total  of  the  "  expended  for  taxes,  repairs  and 
expenses  during  1910  "  column,  when  added  to  the 
total  of  the  "  expended  for  taxes,  repairs  and  expenses 


Examination  of  Insurance  Companies         169 

during  1910  "  column  of  part  3,  should  equal  items 
30  and  31  of  disbursements,  which  are  ''  repairs  and 
expenses  (other  than  taxes  on  real  estate)"  and 
'*  taxes  on  real  estate  "  respectively. 

Schedule  A  —  Part  3 

The  total  of  the  ^'  profit  on  sale  "  column  should 
agree  with  item  41(a)  of  income,  "  gross  profit  on  sale 
of  real  estate." 

The  total  of  the  ' '  loss  on  sale  ' '  column  should  agree 
with  item  46(a)  of  disbursements,  "  gross  loss  on  sale 
of  real  estate." 

Schedule  B 

The  total  of  the  *'  amount  unpaid  December  31st, 
1910  "  column  should  agree  with  item  2  of  assets, 
'*  mortgage  loans  on  real  estate." 

In  the  "  interest  "  subdivision  the  total  of  the 
''  amount  past  due  December  31,  1910  "  column 
should  agree  with  the  first  part  of  item  13  of  assets, 
^'  interest  due  on  mortgages." 

In  the  same  subdivision  the  total  of  the  "  amount 
past  due  December  31,  1910  "  column  should  agree 
with  the  second  part  of  item  13  of  assets,  ''  interest 
accrued  on  mortgages." 

In  the  same  subdivision  the  total  of  '*  gross  amount 
received  during  1910  "  column  should  agree  with  item 
23  of  income,  "  gross  interest  on  mortgage  loans," 
although  there  is  no  way  of  verifying  the  deduction 
which  companies  are  asked  to  make  in  this  item  for 
the  accrued  interest  on  mortgages  acquired  during 
1910. 


170        Examination  of  Insurance  Companies 

Your  attention  is  directed  to  the  fact  that  the  present 
form  of  Schedule  B  contains  a  record  of  not  only  the 
mortgages  in  the  company's  possession  at  the  time 
that  the  statement  was  made,  but  also  all  acquisitions 
and  sales  during  the  statement  year. 

Schedule  C  —  Part  1 

The  total  of  "  amount  loaned  thereon  "  column 
should  agree  with  item  3  of  assets,  ' '  loans  secured  by 
pledge  of  bonds,  stocks  and  other  collateral. ' ' 

In  the  interest  subdivision  the  total  of  ''  amount 
past  due  December  31,  1910  "  column  should  agree 
with  the  first  part  of  item  15  of  assets,  '^  interest  due 
on  collateral  loans." 

In  the  same  subdivision  the  total  of  ''  amount 
accrued  December  31,  1910  "  column  should  agree 
with  the  second  part  of  item  15  of  assets,  *'  interest 
accrued  on  collateral  loans." 

In  the  same  subdivision  the  total  of  ''  amount  re- 
ceived during  1910  "  column  should  agree  with  item 
24  of  income,  *'  gross  interest  on  collateral  loans," 
when  increased  by  the  total  of  the  amount  of  ' '  amount 
received  during  1910  "  of  the  interest  subdivision  in 
part  3  of  this  schedule. 

Schedule  D  — Part  1 

The  total  of  the  '^  book  value  "  column  should  agree 
with  the  first  part  of  item  6  of  assets,  "  book  value 
of  bonds."  The  total  of  "  market  value  "  column 
when  added  to  the  total  of  the  similar  column  in  part 
2  of  the  schedule  should  form  the  basis  for  either  the 
addition  under  item  23  of  assets,  '*  market  value  of 
bonds  and  stocks  over  book  value,"  or  part  of  item 


Examination  of  Insueance  Companies        171 

42  of  assets, ''  book  value  of  ledger  assets  over  market 
value." 

In  the  interest  subdivision  total  of  ''  amount  due 
and  accrued  December  31,  1910  "  column,  should 
agree  with  item  14  of  assets,  ^'  interest  due  and 
accrued  on  bonds."  Your  attention  is  directed  to  the 
fact  that  in  this  schedule  the  past  due  interest  is  not 
separated  from  the  accrued  interest. 

In  the  same  subdivision  the  total  of  "  gross  amount 
received  during  1910  ' '  column  when  added  to  the  total 
of  "  amount  received  during  1910  "  column  in  the 
dividend  subsection  of  part  2,  and  the  total  of  ''in- 
terest or  dividends  received  during  1910  "  column  of 
part  4  should  equal  item  25  of  income,  "  gross  interest 
on  bonds  and  dividends  on  stocks. ' ' 

The  indented  figure  in  item  25  of  income,  "  accrued 
interest  on  bonds  acquired  during  1910  ' '  should  agree 
with  the  total  of  "  paid  for  accrued  interest  on  bonds 
acquired  during  1910  "  column  in  part  3. 

The  total  of  "  increase,  by  adjustment,  in  book  value 
during  1910  "  column  should  agree  with  item  42(b) 
of  income,  "  gross  increase,  by  adjustment,  in  book 
value  of  bonds,"  when  increased  by  that  portion  of 
the  similar  column  in  part  4  of  this  schedule  applying 
to  bonds. 

The  total  of  "  decrease,  by  adjustment,  in  book 
value  during  1910  "  column  should  agree  with  item 
47(b)  of  disbursements,  "  gross  decrease  by  adjust- 
ment in  book  value  of  bonds,"  when  increased  by  that 
portion  of  the  similar  column  in  part  4  of  this  schedule 
applying  to  bonds. 

The  total  of  "  increase  in  amortized  value  during 
1910  "  column  should  agree  with  the  indented  figures 


172        Examination  of  Insurance  Companies 

in  item   42(b)    of   income,   "including   $ for 

accrual  of  discount." 

The  total  of  the  '*  decrease  in  amortized  value  dur- 
ing 1910  "  column  should  agree  with  the  indented 
figure  in  item  47(b)  of  disbursements,  "  including 
$ for  amortization  of  premiums. ' ' 

Schedule  D  — Part  2 

The  total  of  '  *  increase  by  adjustment  in  book  value 
during  1910  "  column  should  agree  with  item  42(c) 
of  income,  "  gross  increase,  by  adjustment,  in  book 
value  of  stocks  "  when  added  to  the  portion  of  the 
similar  column  in  part  4  applying  to  stocks. 

The  total  of  "  decrease  by  adjustment  in  book  value 
during  1910  "  column  should  agree  with  item  47(c) 
of  disbursements,  ''  gross  decrease  by  adjustment  in 
book  value  of  stocks  "  when  added  to  the  portion  of 
the  similar  column  in  part  4  applying  to  stocks. 

Schedule  D  — Part  4 

The  total  of  "  profit  on  sale  "  column  should  agree 
with  items  41(b)  and  41(c)  of  income,  "  gross  profit 
on  sale  or  maturity  of  bonds  "  and  '*  gross  profit  on 
sale  of  stocks." 

The  total  of  "  loss  on  sale  "  column  should  agree 
with  items  46(b)  and  46(c)  of  disbursements,  "  gross 
loss  on  sale  or  maturity  of  bonds  "  and  *'  gross  loss 
on  sale  of  stocks." 

Schedule  E 

The  total  of  "  balance  December  31,  1910  "  column 
should  agree  with  items  8  and  9  of  assets,  ''  deposits 
in  trust  companies  and  banks,  not  on  interest  "  and 
**  deposits  in  trust  companies  and  banks,  on  interest." 


Examination  of  Insurance  Companies        173 

The  total  of  ''  amount  of  interest  received  during 
1910  "  column  should  agree  with  item  27  of  income, 
*'  gross  interest  on  deposits  in  trust  companies  and 
banks. ' ' 

Schedule  F 

The  total  of  "  amount  resisted  December  31st, 
1910  ' '  column  should  agree  with  item  15  of  liabilities, 
**  claims  for  death  losses  and  other  policy  claims 
resisted  by  the  company." 

Schedule  J 

The  total  of  ''  amount  paid  "  column  should  agree 
with  the  indented  figure  in  item  15  of  disbursements, 
together  with  item  28  of  disbursements,  being  the 
**  legal  expenses  in  connection  with  the  investigation 
and  settlement  of  policy  claims  ' '  and  * '  legal  expenses 
not  included  in  item  15, ' '  respectively. 

Schedule  P 

The  total  of  '*  total  ''  column  should  agree  with 
items  33  and  34  of  liabilities,  ''  dividends  declared  on 
or  apportioned  to  deferred  dividend  policies  payable 
to  policyholders  during  1911  "  and  "  amounts  set 
apart,  apportioned,  provisionally  ascertained,  calcu- 
lated, declared  or  held  awaiting  apportionment  upon 
deferred  dividend  policies  not  included  in  item  33." 

Schedule  X 

The  total  of  '*  gross  income  during  1910  "  column 
should  equal  item  34  of  income,  ''  from  other  sources 
(give  items  and  amounts)." 


174        Examination  of  Insurance  Companies 

The  total  of  ''  outlays  made  during  1910  "  column 
should  agree  with  item  38  of  disbursements,  "  other 
disbursements  (give  items  and  amounts)." 

MISCELLANEOUS  BLANK 

The  annual  statement  which  the  miscellaneous  com- 
panies are  required  to  file  requires  no  special  treat- 
ment in  so  far  as  schedules  A,  B,  C  and  D  are  con- 
cerned. The  facts  connected  with  the  special  sched- 
ules, however,  are  as  follows : 

Schedule  H 

The  total  of  "  value  of  property  received  as  sal- 
vage "  column  should  agree  with  item  16  (3)  of  dis- 
bursements, being  the  amount  of  the  salvage  deducted 
from  the  payments  to  policyholders  for  losses. 

Schedules  J  and  K 

The  totals  of  the  *'  estimated  liability  December 
31st,  1910,  per  annual  statement  "  columns  of  these 
two  schedules  when  added  together  should  equal 
item  4  (4)  and  item  5  (4)  of  liabilities,  being  the 
sum  of  the  adjusted,  in  process  of  adjustment  and 
resisted  fidelity  and  surety  losses. 


CHAPTER  XXI 

Excise  Bonds  —  Special  Feature  in  New  York  State  — 
Excise  Reinsurance  Agreement  —  Its  Method  of 
Operation  —  Guaranty  of  Bills  of  Lading  —  Other 
Forms  of  Guaranteed  Certificates. 

In  one  of  my  previous  talks  I  stated  to  you  that  the 
only  forms  of  insurance  which  required  the  insertion 
of  special  items  of  liability  in  their  annual  statements 
were  credit  insurance  and  liability  insurance.  I  pur- 
posely omitted  any  reference  to  the  excise  bonds  which 
are  issued  by  some  surety  companies  and  for  which 
you  will  find  in  the  blank  used  by  the  New  York  Insur- 
ance Department  a  special  item  in  the  liabilities  refer- 
ring, however,  not  to  all  of  the  excise  risks,  but  only 
to  those  that  are  written  on  liquor  dealers  in  New 
York  State.  I  desired  to  refer  to  this  matter  in  a 
separate  talk  and  the  reason  for  the  special  treatment 
of  the  New  York  State  excise  risks  can  be  seen  from 
the  following:  You  will  recall  that  excise  bonds  are 
issued  in  order  that  the  liquor  dealer  may  be  enabled 
to  obtain  his  license  from  the  State,  and  the  companies 
guarantee  that  in  the  event  of  any  conviction  for  viola- 
tion of  the  excise  laws  upon  the  part  of  the  dealer, 
the  penalty  of  the  bond  or  such  part  of  it  as  may  be 
demanded,  will  be  paid.  Formerly  these  bonds  in 
New  York  State  were  issued  in  May  of  each  year;  in 
later  years  and  at  the  present  time  all  of  the  bonds 
are  issued  on  October  1st  of  each  year  and  run  to 

[175] 


176        Examination  of  Insurance  Companies 

September  30th  of  the  next  year.  You  will,  therefore, 
see  that  on  December  31st  of  any  year  these  bonds 
have  been  in  force  only  three  months,  and,  therefore, 
the  New  York  Insurance  Department  requires  the  com- 
panies to  maintain  not  50  per  cent,  of  the  gross  pre- 
miums as  an  unearned  premium  account,  but  insists 
upon  75  per  cent,  being  set  aside  as  a  liability.  This 
treatment  is  in  accordance  with  the  actual  conditions 
and  is,  therefore,  not  a  special  item  such  as  were  the 
liabilities  applicable  to  credit  insurance  and  liability 
insurance,  but  is  simply  the  logical  treatment  of  the 
item,  and  follows  the  general  rule  indicated  in  my 
treatment  of  the  unearned  premium  account. 

Bear  in  mind,  however,  that  this  applies  only  to 
excise  bonds  issued  for  liquor  dealers  in  New  York 
State;  in  other  localities  the  bonds  are  issued  at  vari- 
ous times  throughout  the  year,  and  in  consequence 
the  usual  50  per  cent,  rule  will  be  applicable  in  those 
cases. 

Attached  to  the  excise  business  in  New  York  State 
are  one  or  two  special  features  to  which  I  would  like 
to  direct  your  attention  at  this  time;  the  business  there 
is  done  by  means  of  an  association,  to  which  at  the 
present  time,  I  think,  ten  surety  companies  are  sub- 
scribers. In  other  words,  these  ten  companies  have 
formed  a  pool  and  between  them  handle  all  of  the  New 
York  excise  business,  both  State  and  city.  Repre- 
sentatives of  these  companies  have  met  and  have  ap- 
portioned the  business  among  themselves  according 
to  certain  agreed  ratios.  Companj''  A,  for  instance, 
has  agreed  to  assume  10  per  cent,  of  the  excise  risks, 
will  receive  10  per  cent,  of  all  of  the  premiums  which 
will  be  collected  (after  deducting  the  expenses)  and 


Examination  of  Insueance  Companies        177. 

will  pay  10  per  cent,  of  all  of  the  excise  losses  which 
are  sustained  in  the  State  of  New  York.  Company  B, 
being  smaller  desires  only  to  be  a  participant  to  the 
extent  of  5  per  cent.,  will  receive  5  per  cent,  of  the 
premiums  and  be  responsible  for  5  per  cent,  of  the 
losses.  The  bonds  are  issued  in  the  names  of  the  indi- 
vidual companies,  i.  e.,  in  the  interior  towns,  for 
instance,  the  agent  of  Company  A  will  issue  bonds 
binding  his  company,  but  if  a  loss  should  result  under 
that  bond.  Company  A  would  not  be  required  to  pay 
the  entire  loss,  but  would  be  responsible  for  only  its 
proportion  as  determined  by  the  excise  association, 
and  the  balance  would  be  met  by  the  other  subscribers 
according  to  their  respective  proportions. 

While  a  company  is  liable  for  that  percentage  of 
the  total  losses  which  it  has  agreed  to  underwrite,  you 
will  find  that  it  does  not  at  once  receive  that  percent- 
age of  the  premium  receipts.  All  of  the  premiums 
which  are  collected  go  to  the  executive  committee  of 
the  association,  are  deposited  in  some  bank,  and  the 
committee,  before  distributing  them  between  the  vari- 
ous subscribers,  sets  aside  a  reserve  fund  in  order  to 
take  care  of  the  losses  which  may  be  claimed  by  the 
State  at  any  time  within  three  years  after  the  bond 
has  been  issued,  although  the  year  for  which  the  bond 
ran  expired  some  time  before.  In  other  words,  if  a 
bond  were  issued  on  October  1,  1910,  it  would  cover 
the  liquor  dealer  for  the  year  expiring  September  30, 
1911,  but  the  State  could  at  any  time  within  two  years 
after  September  30, 1911,  sue  upon  this  bond  to  recover 
a  penalty  for  any  violation  which  occurred  prior  to 
that  date.  While  this  is  the  broad,  general  purpose 
of  the  reserve  fund,  it  is  aimed  to  pay  all  of  the  losses 

12 


178        Examination  of  Insurance  Companies 

out  of  the  other  funds.  Let  us  suppose,  for  instance, 
that  Company  A  is  compelled  to  pay  a  loss  of  $1,000 
and  that  its  share  of  participation  in  the  excise  asso- 
ciation is  10  per  cent.  When  the  loss  is  to  be  paid. 
Company  A  sends  its  cheque  for  $1,000  to  the  proper 
State  officer  and  receives  at  the  same  time  a  cheque 
from  the  executive  committee  for  $900,  the  share  of 
the  other  subscribers.  This  payment  is  made  by  the 
executive  committee,  not  from  the  reserve  fund  just 
referred  to,  but  from  a  fund  intended  to  provide  for 
current  losses,  and  which  it  aims  to  always  keep  at  a 
certain  figure. 

These  funds  are  deposited  in  the  bank  not  in  the 
names  of  the  individual  companies,  but  in  the  name  of 
the  association,  and  in  consequence  some  question  has 
arisen  as  to  the  right  of  the  company  to  include  its 
share  of  the  current  loss  fund  and  the  reserve  fund 
among  its  deposits  in  preparing  the  annual  statement 
for  filing  with  the  various  Departments.  The  usual 
tests  which  we  apply  to  determine  the  admissibility  of 
a  bank  deposit  are,  first,  is  the  deposit  to  the  credit 
of  the  corporation,  and  second,  is  it  subject  to  with- 
drawal by  its  cheque.  The  result  of  applying  both  of 
these  tests  would  seem  to  indicate  that  these  deposits 
could  not  be  included  among  the  bank  deposits,  but 
should  be  scheduled  as  a  separate  and  distinct  asset. 
This  is  a  technical  matter  which  is  usually  passed 
upon  by  each  Department  according  to  its  own  judg- 
ment, and  mention  of  it  is  made  here  merely  to  account 
for  the  presence  in  the  annual  statement  blank  of  what 
may  at  first  glance  appear  to  be  an  unusual  entr^\ 

There  is  another  form  of  guaranty  which  may  come 
into  prominence  in  the  course  of  the  next  year,  and 


Examination  of  Insurance  Companies        179 

that  is  the  guaranty  of  bills  of  lading  for  cotton  ship- 
ments from  the  South.  The  owners  ship  their  cotton 
and  the  foreign  banks  have  been  in  the  habit  of  ad- 
vancing money  on  the  bills  of  lading  which  shippers 
presented.  Owing  to  the  fact  that  bills  in  the  past 
have  been  forged,  the  foreign  bankers  have  become 
less  willing  to  accept  these  bills  and  have  insisted 
upon  some  sort  of  a  guaranty.  Quite  recently  it  was 
decided  to  form  a  corporation  for  the  purpose  of  guar- 
anteeing the  bills  of  lading  for  the  foreign  bankers. 
A  company  of  this  kind  would  in  all  probability  be 
required  to  conform  to  the  insurance  laws  relating  to 
surety  companies,  for  there  seems  to  me  to  be  no  dis- 
tinction between  this  form  of  guaranty  and  forms  of 
warehouse  receipts,  which  are  not  unusual  at  the  pres- 
ent time.  I  think  it  not  unlikely  that  the  business 
which  I  have  just  described  may  eventually  be  taken 
up  by  the  surety  companies  now  established  and 
simply  run  as  a  branch  of  their  business.  When  the 
time  comes,  it  will  be  necessary  to  formulate  laws  for 
the  proper  regulation  of  the  business,  as  it  will  present 
certain  features  which  are  not  found  at  the  present 
time  in  the  usual  transactions  of  the  companies. 

I  also  wish  to  call  your  attention  to  the  fact  that 
you  may  be  brought  in  contact  with  a  form  of  ' '  guar- 
anteed "  certificates  which  are  not  issued  by  surety 
companies  and  which  have  no  relation  to  them.  Some 
life  insurance  companies  in  the  past  have  been  formed, 
and  in  lieu  of  capital  stock,  have  received  contribu- 
tions from  the  organizers  for  the  purpose  of  meeting 
the  initial  expense  of  organization;  in  exchange  for 
these  contributions,  certificates  have  been  issued  pro- 
viding for  the  payment  of  interest  at  a  certain  rate, 


180        Examination  of  Insurance  Companies 

and  the  payment  of  the  principal  at  some  time  in  the 
future.  These  payments  are  to  be  made  out  of  the 
expense  fund  or  loading  of  the  jDremiums,  and  the 
question  has  arisen  in  a  number  of  the  States  as  to 
the  necessity  for  charging  these  certificates  as  liabili- 
ties in  the  annual  statements  of  the  companies  in  the 
same  way  that  we  charge  capital  stock  at  the  present 
time.  They  provide,  you  will  notice,  not  for  a  par- 
ticipation in  the  assets  or  from  any  source  of  interest 
income,  but  are  payable  out  of  the  expense  funds  only. 
For  this  reason,  the  legal  officers  of  the  States  to  which 
the  question  has  been  referred,  have  in  a  number  of 
cases  decided  that  these  outstanding  guaranteed  cer- 
tificates are  not  liabilities. 


CHAPTER  XXII 

Limitation  of  Risk  —  Logic  of  Statutes  —  Limitation 
as  Applied  to  Liability  Policies  —  To  Credit  Policies 
—  Policies  in  Hands  of  Agents  —  Method  of  Verify- 
ing Unearned  Premium  Item. 

Some  of  the  topics  which  I  wish  to  take  up  with  you 
this  morning  are  either  collateral  to  some  of  the  mat- 
ters about  which  I  have  already  spoken  to  you,  or 
have  been  briefly  referred  to  in  my  previous  talks. 
We  find,  for  instance,  that  one  of  the  points  to  which 
we  should  direct  our  attention  in  examining  a  com- 
pany or  auditing  its  books,  is  to  ascertain  whether  it 
has  kept  within  the  limits  which  are  prescribed  for  it 
by  the  law  in  relation  to  the  amount  which  it  is  per- 
mitted to  carry  on  any  one  risk. 

It  must  be  clear  to  you  that  the  basic  idea  of  insur- 
ance is  the  distribution  of  the  losses  which  the  few 
sustain  in  such  a  way  that  the  shock  will  be  felt  over 
as  large  an  area  as  possible  and,  therefore,  with 
diminished  effect  upon  each  participant.  Bearing  this 
in  mind,  it  must  be  equally  clear  to  you  that  if  an 
insurance  company  is  to  retain  its  solvency,  it  must  so 
distribute  its  risks  as  to  permit  the  law  of  averages 
to  operate;  otherwise  its  transactions  will  be  in  the 
nature  of  a  gamble  or  a  matter  of  chance.  Take  the 
case  of  a  fire  insurance  company  that  confined  its 
operations  to  the  risks  in  one  building  only;  you  can 
readily  see  that  a  fire  in  that  building  might  destroy 

[181] 


182        Examination  of  Insurance  Companies 

the  company.  As  long  as  no  fire  occurred,  all  of  the 
earned  premiums  not  needed  for  expense  purposes 
would  be  profit,  but  such  a  condition  would  be  very 
unsafe.  The  proper  distribution  of  a  company 's  risks, 
therefore,  is  an  important  matter  and  one  upon  which 
its  continued  solvency  will  depend. 

For  this  reason  we  find  on  the  statute  books  of  a 
number  of  the  States,  laws  limiting  the  amounts  which 
a  company  may  write  on  a  single  risk.  In  the  Com- 
monwealth of  Massachusetts,  for  instance,  we  find  that 
a  portion  of  section  20  of  the  Insurance  Law  is  as 
follows : 

''  No  insurance  company  authorized  to  transact 
business  in  this  commonwealth  shall  insure  in  a 
single  risk,  wherever  such  risk  is  located,  a  larger 
amount  than  one  tenth  of  its  net  assets,  unless  it 
has  provided  for  reinsurance  of  the  excess  over 
said  limit,  to  take  effect  simultaneously  with  the 
original  contract;  and  if  any  foreign  insurance 
company  violates  this  provision,  the  insurance 
commissioner  may  revoke  its  authority  to  trans- 
act business  in  this  commonwealth;  but  a  mutual 
boiler  insurance  company  of  this  commonwealth 
may  insure  in  a  single  risk  an  amount  not  exceed- 
ing one  fourth  of  its  net  assets." 

The  wording  of  this  section  is  so  clear  as  to  prac- 
tically require  no  further  explanation  upon  my  part. 
I  desire,  however,  to  call  your  attention  to  the  fact 
that  you  must  use  considerable  care  in  applying  the 
limitations  of  this  section. 

No  question  will  arise  in  its  application  to  a  life  or 
a  fire  or  a  personal  accident  company,  for  there  the 
question  of  the  risk  which  is  covered  is  quite  clear, 


Examination  of  Insueance  Companies         183 

although  in  the  case  of  a  fire  insurance  company  care- 
ful underwriters  impose  an  additional  restriction  upon 
their  operations  by  limiting  the  amount  which  they  will 
carry  in  any  one  block.  You  will  find  that  fire  insur- 
ance companies  keep  a  very  accurate  record  of  the 
way  in  which  their  risks  are  distributed,  and  do  every- 
thing possible  to  prevent  the  "  conflagration  hazard." 

When  you  come  to  apply  the  law  to  liability  and 
credit  companies,  the  application  becomes  more  in- 
volved and  presents  some  unusual  features.  You  will 
recall  that  when  I  talked  about  liability  policies,  I 
pointed  out  that  a  policy  is  sometimes  designated  as 
a  $5,000-$50,000  policy.  By  this  is  meant  that  the 
company  is  liable  only  to  the  extent  of  $5,000  on  any 
one  life,  but  is  liable  to  the  extent  of  $50,000  as  a  result 
of  any  one  accident.  If  the  next  day  another  accident 
occurred  so  that  the  same  insured  would  have  to  pay 
damages,  the  liability  company  would  again  be  in  a 
position  where  it  would  have  to  furnish  protection 
within  these  limits.  It  would  seem,  therefore,  that 
the  wording  of  the  statute  "  shall  insure  in  a  single 
risk  "  would  mean  in  this  case  that  $50,000  is  the 
measure  of  the  amount  involved  in  a  single  risk. 

In  the  case  of  credit  companies  you  will  recall  that 
a  similar  designation  is  used,  but  the  meaning  is 
different.  For  instance,  a  $5,000-$50,000  policy  would 
mean  that  after  the  insured's  initial  loss  had  been 
exceeded,  a  credit  company  would  be  responsible  or 
liable  to  the  extent  of  $5,000  for  any  one  insolvent 
customer,  and  its  total  limit  would  be  $50,000.  Once 
that  limit  has  been  reached,  the  credit  company  could 
never  be  called  upon  to  pay  more  than  $50,000.  Here 
it  must  be  manifest  to  you  that  the  limit  on  any  single 


184        Examination  of  Insurance  Companies 

risk  is  not  $50,000,  but  $5,000,  because  there  is  no 
reason  to  assume  that  any  event  which  causes  the 
insolvency  of  one  customer  is  going  to  cause  the  insol- 
vency of  another  customer. 

There  is  another  matter  to  which  I  have  referred, 
and  that  is  the  method  of  checking  the  outstanding 
policies.  In  the  case  of  fire,  accident  and  some  other 
forms  of  insurance,  the  policies  are  not  issued  at  the 
home  office  of  the  company,  but  forms  are  placed  in 
the  hands  of  the  agents  and  the  policies  are  issued 
directly  by  them,  notification  being  sent  to  the  home 
office  of  the  company  either  in  the  form  of  daily 
reports,  lists  of  policies  or  some  other  similar  way. 
In  the  case  of  personal  accident  companies  we  find  a 
great  many  forms  of  policies  issued,  and  in  conse- 
quence the  agents  have  in  their  hands  a  number  of  sets 
of  policies.  It  is  necessary,  therefore,  to  check  up 
the  policy  forms  in  their  hands  to  ascertain  whether 
all  of  the  policies  which  have  been  issued  have  been 
reported  to  the  home  office;  this  is  important  in  that 
we  are  interested,  first,  to  ascertain  whether  the  com- 
pany is  carrying  the  proper  amount  of  unearned  pre- 
mium as  a  liability  on  its  outstanding  risks,  and 
second,  whether  the  company  is  receiving  the  pre- 
miums represented  by  all  of  the  policies  which  have 
been  issued  by  the  agents.  An  agent,  you  will  see, 
has  the  opportunity,  should  he  be  so  inclined,  to  issue 
a  policy,  fail  to  report  it  at  the  home  office,  and  put 
the  premium  in  his  pocket.  Such  a  condition  would 
never  be  revealed  unless  a  loss  were  reported  on  such 
policy  or  unless  the  policy  forms  remaining  with  the 
agent  are  checked  with  the  record  at  the  home  office. 
We  should  find  that  for  every  policy  which  has  been 
placed  in  his  hands,  the  agent  has  either  reported  its 


Examination  of  Insukance  Companies        185 

issuance,  has  returned  the  policy  as  spoiled,  or  still 
has  the  form  in  his  possession.  It  is  important  both 
from  the  standpoint  of  the  auditor  and  the  examiner 
that  this  phase  of  the  company's  transactions  should 
be  closely  guarded. 

I  also  wish  to  refer  briefly  to  the  proper  method  of 
determining  the  unearned  premium  account  of  a  fire 
insurance  company  or  any  company  which  lists  its 
premiums  by  expirations.  A  recent  case  of  falsifica- 
tion of  its  annual  statement  by  a  fire  insurance  com- 
pany has  received  some  attention,  and  I  think  the  best 
way  to  make  this  clear  to  you  is  to  take  this  specific 
case  and  show  the  steps  which  led  to  the  determination 
of  the  falsification.  The  company  in  question  reported 
that  the  gross  premiums  which  it  had  written  during 
the  year  1909,  less  reinsurance  and  return  premiums, 
amounted  to  $1,505,073.  The  recapitulation  of  its  fire 
risks  and  premiums  which  purported  to  analyze  its 
unearned  premium  account,  was  shown  in  its  sworn 
statement  as  follows: 

Gross 
premiums 
charged, 

Year                                                               less  Fraction  Premiums 

written                  Term                            reinsiu-ance  unearned  '     unearned 

1909    One  year  or  less $602,075.10  1-2  $301,037.55 

1908  It,                                                 f         5,465.16  1-4  1,366.29 

1909 /^^°y^^" \         9,295.62  3-4  6,971.72 

1907]                                                     f     200,469.20  1-6  33,411,53 

1908  I  Three  years -j      193,865.46  1-2  96,932.73 

1909  J  I  286,720.87  5-6  238,934.06 
1906]                                                     (         2,716.98  1-8  339.62 

1907  !  ^„,„  „„„^  ]  5 ,  007 ,  71         3-8  1 ,  877 .  89 

1908  f  *°"^y®*" I         2,375.21         5-8  1,484.51 

1909  1  [         3,251.58        7-8  2,845.13 

1905  1  f       93,644.35         1-10  9,364.43 

1906  I      106,412.56        3-10  31,923.76 

1907  I  Five  years ■!      100,404.40         1-2  50,202.20 

1908  I   95,878.74    7-10      67,115.11 

1909  J  [  127,044.24    9-10     114,339.81 

$1,834,627.18  $958,146.34 


186        Examination  of  Insurance  Companies 

From  the  above  table  you  will  see  that  the  premiums 
outstanding  on  December  31,  1909,  on  business  written 
during  1909,  was  as  follows: 

One  year  or  less $602,075.10 

Two  years   9,295.62 

Three  years 286,720.87 

Four  years 3,251 .  58 

Five  years    127,044. 24 

$1,028,387.41 


It  would  appear,  therefore,  that  if  this  recapitula- 
tion were  correct,  the  difference  between  the  net  writ- 
ings as  shown  in  the  income  portion  of  the  statement, 
$1,505,073,  and  the  1909  issues  in  force  on  December 
31st,  $1,028,387.41,  or  $476,685.59,  represented  the -pre- 
miums upon  business  which  had  been  issued  during 
1909,  but  which  had  expired  before  the  end  of  that 
year.  That  a  company  should  have  issued  one-third 
of  its  total  writings  on  a  short  term  basis  of  this  kind 
is  so  absurd  as  to  at  once  indicate  that  something  is 
wrong.  This  condition  once  having  been  ascertained, 
there  is  only  one  safe  way  to  compute  the  unearned 
premium  account,  and  that  is  to  disregard  the  books 
of  the  company  entirely  and  work  from  the  daily  re- 
ports, which  should  show  the  policies  still  in  force,  the 
premiums  received,  the  reinsurance  which  has  been 
effected  and  all  other  data  necessary  for  the  computa- 
tion. I  might  add  a  word  of  caution,  however,  to  this 
effect  —  do  not  fail  to  make  an  occasional  check  on  the 
daily  reports,  in  order  to  make  sure  that  none  has  been 
taken  from  the  files.  This  can,  of  course,  be  done  by 
noticing  if  any  serial  numbers  in  any  agency  are  miss- 
ing, and  if  so,  what  explanation  of  this  condition  can 
be  offered. 


APPENDICES 


[187] 


APPENDIX  A 

The  restrictions  placed  on  the  ownership  of  real 
estate  by  the  New  York  Insurance  Law  are  as  follows : 

* '  §  20.  Every  insurance  corporation  transacting 
business  in  this  state  may  purchase,  hold  and  con- 
vey real  property  only  for  the  following  purposes 
and  in  the  following  manner : 

*'  1.  The  building  in  which  it  has  its  principal 
office  and  the  land  upon  which  it  stands. 

' '  2.  Such  as  shall  be  requisite  for  its  convenient 
accommodation  in  the  transaction  of  its  business. 

"  3.  Such  as  shall  have  been  acquired  for  the 
accommodation  of  its  business. 

'*  4.  Such  as  shall  have  been  mortgaged  to  it  in 
good  faith  by  way  of  security  for  loans  previously 
contracted  or  for  moneys  due. 

**  5.  Such  as  shall  have  been  conveyed  to  it  in 
satisfaction  of  debts  previously  contracted  in  the 
course  of  its  dealings. 

* '  6.  Such  as  shall  have  been  purchased  at  sales 
upon  judgments,  decrees  or  mortgages  obtained 
or  made  for  such  debts. 

'*  7.  Such  as  shall  have  been  acquired  under 
sections  thirteen  and  fourteen  of  the  general  cor- 
poration law. ' ' 

[189J 


190        Examination  of  Insueance  Companies 


APPENDIX  B 

The  requirements  relative  to  the  disposition  of  real 
estate  in  New  York  are  illustrated  by  the  following 
quotation  from  section  20  of  the  Insurance  Law: 

''All  such  real  property  specified  in  subdivi- 
sions three,  four,  five,  six  and  seven  of  this  sec- 
tion, as  shall  not  be  necessary  for  its  accommoda- 
tion in  the  convenient  transaction  of  its  business, 
shall  be  sold  and  disposed  of  within  five  years 
after  it  shall  have  acquired  title  to  the  same,  or 
within  five  years  after  the  same  shall  have  ceased 
to  be  necessary  for  the  accommodation  of  its  busi- 
ness, and  it  shall  not  hold  such  property  for  a 
longer  period  unless  it  shall  procure  a  certificate 
from  the  superintendent  of  insurance  that  its  in- 
terests will  suffer  materially  by  the  forced  sale 
thereof,  in  which  event  the  time  for  the  same  may 
be  extended  to  such  time  as  the  superintendent 
shall  direct  in  such  certificate.  If  it  is  a  domestic 
marine  insurance  corporation,  it  may  also  acquire 
and  hold  such  real  property  within  the  state  or 
upon  or  in  its  waters  as  is  or  may  be  adapted  to 
or  available  for  use  in  protecting,  storing  and 
caring  for  wrecked  vessels  or  cargoes,  or  in  pro- 
tecting, storing  and  caring  for  such  vessels  and 
appliances  as  are  or  may  be  employed  for  assist- 
ing the  same,  or  is  or  may  be  adapted  to  or  avail- 
able for  other  purposes  of  or  incident  to  marine 
salvage  service,  and  may  manage  and  dispose  of 
such  real  property  in  the  same  manner  and  with 
like  effect  as  if  it  were  an  unincorporated  owner 
thereof.  No  real  property  shall  be  acquired  by 
any  domestic  life  insurance  corporation  under 
subdivisions  one  or  two  hereof  or  under  section 
fourteen  of  the  general  corporation  law  and  no 


Examination  of  Insurance  Companies         191 

real  property  within  the  state  shall  be  acquired 
by  any  foreign  life  insurance  corporation  under 
subdivision  two  hereof,  except  with  the  approval 
of  the  superintendent  of  insurance.  No  real  prop- 
erty shall  be  disposed  of  by  any  domestic  life  in- 
surance corporation  and  no  real  property  within 
the  state  shall  be  disposed  of  by  any  foreign  life 
insurance  corporation,  by  exchange  for  other  real 
property,  wherever  situated,  as  the  consideration 
for  the  transfer  in  whole  or  part,  unless  the  acqui- 
sition of  the  latter  shall  be  requisite  for  the  con- 
venient accommodation  of  the  corporation  in  the 
transaction  of  its  business  and  shall  be  approved 
by  the  superintendent." 


192        Examination  of  Insurance  Companies 
APPENDIX  C 

Office  of 

S.  H.  Wolfe, 

Consulting  Actuary, 

165  Broadway,  New  York. 

New  York, , 

M 


Dear  : 

The  Insurance  Department.,  of  the  State.,  of 
is  (are)  now  conducting  an  ex- 
amination of  the   Company  of 

,   and   find  among  its   assets   a  mortgage 

executed    by     upon    property 

owned  by  you  and  located 

According  to  the  books  of  the  company  on 

19..,    the    unpaid    principal    of    the    mortgage    was 

$ 

Will  you  please  inform  me  if  this  amount  is  correct? 

Answer  yes  or  no If  not  correct  what  is 

the  right  amount  ?    $ 

The  examination  now  being  made  is  required  under 
the  laws  of  the  State  and  this  notice  does  not  affect 
your  loan  in  any  way.  It  does  not  mean  that  the  com- 
pany desires  you  to  pay  it  or  that  any  objection  has 
been  made  to  it.  This  information  is  asked  for  only 
to  enable  the  examiner  to  verify  the  entries  in  the  com- 
pany's books  and  by  signing  this  notice  below  and  re- 
turning it  in  the  enclosed  stamped  envelope  you  will 
aid  the  work.        Very  respectfully. 


> 

Examiner. 


Owner  please  sign  here 


Examination  of  Insurance  Companies        193 


APPENDIX  D 

''  §  36.  No  director  or  officer  of  an  insurance  corpo- 
ration doing  business  in  this  state  shall  receive  any 
money  or  valuable  thing  for  negotiating,  procuring, 
recommending  or  aiding  in,  any  purchase  by  or  sale  to 
such  corporation  of  any  property,  or  any  loan  from 
such  corporation,  nor  be  pecuniarily  interested,  either 
as  principal,  co-principal,  agent  or  beneficiary,  in  any 
such  purchase,  sale  or  loan;  provided  that  nothing 
herein  contained  shall  prevent  a  life  insurance  corpo- 
ration from  making  a  loan  upon  a  policy  held  therein 
by  the  borrower  not  in  excess  of  the  net  value  thereof. 
Any  person  violating  any  provision  of  this  section 
shall  be  guilty  of  a  misdemeanor." 
13 


194        Examination  of  Insurance  Companies 


APPENDIX  E 

"  §  100.  No  domestic  life  insurance  corporation, 
whether  incorporated  by  special  act  or  under  a  general 
law,  shall  invest  in  a  loan  or  upon  any  shares  of  stock 
of  any  corporation,  other  than  a  municipal  corpora- 
tion, nor,  excepting  government,  state  or  municipal 
securities,  shall  it  invest  in,  or  loan  upon,  any  bonds 
or  obligations  which  shall  not  be  secured  by  adequate 
collateral  security  or  where  more  than  one-third  of  the 
total  value  of  the  collateral  security  therefor  shall  con- 
sist of  shares  of  stock.  Every  such  corporation  which 
on  the  first  day  of  June,  nineteen  hundred  and  six, 
owned  any  shares  of  stock  other  than  public  stock  of 
municipal  corporations,  whenever  the  same  were  ac- 
quired, or  any  bonds  or  obligations  of  the  kinds  above 
described  where  said  bonds  or  obligations  were  ac- 
quired after  the  first  day  of  March,  nineteen  hundred 
and  six,  shall  dispose  of  said  shares  of  stock  and  of 
said  bonds  and  obligations  within  five  years  from  the 
thirty-first  day  of  December,  nineteen  hundred  and 
six,  and  in  each  year  prior  to  the  expiration  of  said 
five  years  shall  make  such  reduction  of  its  holdings  of 
said  securities  as  may  be  approved  in  writing  by  the 
superintendent  of  insurance.  No  investment  or  loan 
shall  be  made  by  any  such  life  insurance  corporation 
unless  the  same  shall  first  have  been  authorized  by  the 
board  of  directors  or  by  a  committee  thereof  charged 
with  the  duty  of  supervising  such  investment  or  loan. 
No  such  corporation  shall  subscribe  to  or  participate 
in  any  underwriting  of  the  purchase  or  sale  of  securi- 


Examination  of  Insurance  Companies        195 

ties  or  property,  or  enter  into  any  transaction  for  such 
purchase  or  sale  on  account  of  said  corporation  jointly 
with  any  other  person,  firm  or  corporation ;  nor  shall 
any  such  corporation  enter  into  any  agreement  to 
withhold  from  sale  any  of  its  property,  but  the  dispo- 
sition of  its  property  shall  be  at  all  times  within  the 
control  of  its  board  of  directors.  Any  such  corpora- 
tion, in  addition  to  other  investments  allowed  by  law, 
may  invest  any  of  its  funds  in  any  duly  authorized 
bonds  or  evidences  of  debt  of  any  city,  county,  town, 
village,  school  district,  municipality  or  other  civil  di- 
vision of  any  state  and  may  loan  upon  the  security  of 
improved  unincumbered  real  property  in  any  state 
worth  fifty  per  centum  more  than  the  amount  loaned 
thereon.  Provided,  however,  that  nothing  in  this  sec- 
tion contained  shall  be  construed  as  prohibiting  a  life 
insurance  company  from  entering  into  an  agreement 
for  the  purpose  of  protecting  the  interests  of  the  com- 
pany in  securities  lawfully  held  by  it,  or  for  the  purpose 
of  reorganization  of  a  corporation  which  issued  securi- 
ties so  held,  and  from  depositing  such  securities  with  a 
committee  or  depositaries  appointed  under  such  agree- 
ment ;  but  such  agreement  and  the  deposit  of  securities 
thereunder  must  first  be  approved  in  writing  by  the 
superintendent  of  insurance  with  a  statement  of  his 
reasons  for  such  approval.  Nor  shall  this  section  be 
construed  as  preventing  such  company  from  accepting 
corporate  stock  or  bonds  or  other  securities,  which 
may  be  distributed  pursuant  to  any  such  agreement 
approved  as  aforesaid  or  to  any  plan  of  reorganiza- 
tion approved  in  writing  by  the  superintendent  of 
insurance  with  a  statement  of  his  reasons  for  such 


196  EXAMHSTATION    OF    INSURANCE    COMPANIES 

approval.  But  if  any  securities  so  received  shall  con- 
sist in  whole  or  in  part  of  stock  in  any  corporation  or 
of  bonds  or  obligations  which  shall  not  be  secured  by 
adequate  collateral  security  or  where  more  than  one- 
third  of  the  total  value  of  the  collateral  security  there- 
for shall  consist  of  shares  of  stock,  then  any  stock  and 
any  such  bond  or  obligation  so  received  shall  be  dis- 
posed of  within  five  years  from  the  time  of  their  acqui- 
sition or  before  the  expiration  of  such  further  period 
or  periods  of  time  as  may  be  fixed  in  writing  for  that 
purpose  by  the  superintendent  of  insurance. 


Examination  of  Insurance  Companies        197 


APPENDIX  F 

'*  §  16.  The  cash  capital  of  every  domestic  insurance 
corporation  required  to  have  a  capital,  to  the  extent  of 
the  minimum  capital  required  by  law,  shall  be  invested 
and  kept  invested  in  the  kinds  of  securities  in  which 
deposits  with  the  superintendent  of  insurance  are  re- 
quired by  this  chapter  to  be  made.  The  residue  of  the 
capital  and  the  surplus  money  and  funds  of  every 
domestic  insurance  corporation  over  and  above  its  cap- 
ital, and  the  deposit  that  it  may  be  required  to  make 
with  the  superintendent,  may  be  invested  in  or  loaned 
on  the  pledge  of  any  of  the  securities  in  which  deposits 
are  required  to  be  invested  or  in  the  public  stocks  or 
bonds  of  any  one  of  the  United  States,  or  except  as  in 
this  chapter  otherwise  provided,  in  the  stocks,  bonds 
or  other  evidence  of  indebtedness  of  any  solvent  insti- 
tution incorporated  under  the  laws  of  the  United 
'States  or  of  any  state  thereof,  or  in  such  real  estate 
as  it  is  authorized  by  this  chapter  to  hold ;  but  no  such 
funds  shall  be  invested  in  or  loaned  on  its  own  stock 
or  the  stock  of  any  other  insurance  corporation  carry- 
ing on  the  same  kind  of  insurance  business,  except 
that  any  such  company  engaged  solely  in  business  as 
a  surety  company  under  subdivision  four  of  section 
seventy  of  this  chapter  may  invest  such  funds  in,  or 
loan  such  funds  on,  the  stock  of  any  other  corporation 
carrying  on  solely  the  same  kind  of  business  outside 
of,  but  not  within,  the  United  States.  Any  domestic 
insurance  corporation  may,  by  the  direction  and  con- 
sent of  two-thirds  of  its  board  of  directors,  managers 
or  finance  committee,  invest,  by  loan  or  otherwise,  any 


198        Examination  of  Insurance  Companies 

such  surplus  moneys  or  funds  in  the  bonds  issued  by 
any  city,  county,  town,  village  or  school  district  of  this 
state,  pursuant  to  any  law  of  this  state.  Any  corpora- 
tion organized  under  subdivision  one-a,  section  one 
hundred  and  seventy  of  this  chapter,  for  guaranteeing 
the  validity  and  legality  of  bonds  or  other  evidences  of 
indebtedness  issued  by  any  state,  or  by  any  city, 
county,  town,  village,  school  district,  municipality,  or 
other  civil  division  of  any  state,  may  invest  by  loan 
or  otherwise  any  of  such  surplus  moneys  or  funds,  as 
provided  in  section  one  hundred  of  this  chapter. 
Every  such  domestic  corporation  doing  business  in 
other  states  of  the  United  States  or  in  foreign  coun- 
tries may  invest  the  funds  required  to  meet  its  obliga- 
tion incurred  in  such  other  states  or  foreign  countries, 
and  in  conformity  to  the  laws  thereof,  in  the  same  kind 
of  securities  in  such  other  states  or  foreign  countries 
that  such  corporation  is  by  law  allowed  to  invest  in 
this  state.  Any  life  insurance  company  may  lend  a 
sum  not  exceeding  the  lawful  reserve  which  it  holds 
upon  any  policy,  on  the  pledge  to  it  of  such  policy  and 
its  accumulations  as  collateral  security.  But  nothing 
in  this  section  shall  be  held  to  authorize  one  insurance 
corporation  to  obtain,  by  purchase  or  otherwise,  the 
control  of  any  other  insurance  corporation." 


Examination  of  Insueance  Companies        199 
APPENDIX  G 


Office  of 

S.  H.  Wolfe, 

Consulting  Actuary, 

New  York,  N.  Y. 


Examination  of 

for  the 
Insurance  Department 
of 

New  York,  N.  Y., ,19.. 


Gentlemen : 

Among  the  assets  of  the 

on 19 . .  is  a  deposit  in  your  institution.    For 

the  sole  purpose  of  verifying  its  books  will  you  please 
fill  out  the  attached  certificate  and  return  it  in  the  en- 
closed stamped  envelope. 

Very  respectfully  yours, 


(Perforated.) 


(Location)   

(Date)  

This   is  to   certify   that   at   the   close   of  business 

19 . . ,  the  books  of  the 

showed  a  balance  of 

$ due  the and  subject 

to  its  cheque  and  withdrawal;  there  were  also  cer- 
tificates   of    deposits    outstanding    for    $ 

due   


200        Examination  of  Insurance  Companies 

On  the  same  date,  the   was 

not  indebted  to  this  institution  for  borrowed  money, 
discounted  notes  or  under  any  other  form  of  agree- 
ment, or  are  any  of  the  aforementioned  deposits  held 
by  this  institution  as  security  for  any  loan  made  to  an 
officer,  director  or  employee  of  said 

By  

Cashier,  President  or  Treasurer. 

[Printed  in  Copying  Ink.] 


Examination  of  Insurance  Companies         201 


XI 
Q 

< 


►a  oZ 


3^ 


HO 


Mean 

reserve 

maintained 

Hi 

Other 
credits 
claimed 

Net 
deferred 
premium 

Net 

uncollected 

premiima 

a 
i3 

Amount 

of  policy 

loan 

ii 

202        Examination  of  Insurance  Companies 

APPENDIX  I 

**  §  18.  If  any  domestic  insurance  corporation  shall 
have  invested  any  of  its  funds  in  or  loaned  any  of  its 
funds  upon  the  stock,  bonds  or  other  evidences  of  debt 
of  other  corporations  or  of  any  nation,  State,  county, 
city,  town,  village,  school  district,  municipality  or 
other  civil  division  of  any  state,  pursuant  to  the  laws 
of  this  state,  and  the  superintendent  shall  have  reason 
to  believe  that  such  stock,  bonds  or  other  evidences  of 
debt  are  not  amply  secured  or  are  not  yielding  an  in- 
come, he  may  direct  it  to  report  to  him  under  oath 
the  amount  thereof,  the  security  therefor  and  its  mar- 
ket value.  No  stock  and  no  bonds  or  other  evidence  of 
debt  if  in  default  as  to  principal  or  interest,  or  if  not 
amply  secured,  shall  be  valued  as  an  asset  of  the  cor- 
poration above  its  market  value.  All  bonds  or  other 
evidences  of  debt  shall,  if  amply  secured  and  if  not  in 
default  as  to  principal  or  interest,  be  valued  as  follows : 
if  purchased  at  par,  at  the  par  value;  if  purchased 
above  or  below  par,  on  the  basis  of  the  purchase  price 
adjusted  so  as  to  bring  the  value  to  par  at  maturity 
and  so  as  to  yield  meantime  the  effective  rate  of  inter- 
est at  which  the  purchase  was  made ;  provided  that  the 
purchase  price  shall  in  no  case  be  taken  at  a  higher 
figure  than  the  actual  market  value  at  the  time  of  pur- 
chase, and  provided  further  that  the  superintendent  of 
insurance  shall  have  full  discretion  in  determining  the 
method  of  calculating  values  according  to  the  fore- 
going rule,  and  the  values  found  by  him  in  accordance 
with  such  method  shall  be  final  and  binding;  provided, 
also,  that  any  such  corporation  may  return  such  bonds 
or  other  evidences  of  debt  at  their  market  value  or 
their  book  value,  but  in  no  event  at  an  aggregate  value 
exceeding  the  aggregate  of  the  values  calculated  ac- 
cording to  the  foregoing  rule." 


Examination  of  Insurance  Companies        203 

APPENDIX  J 

*  ' '  There  shall  also  be  charged  as  a  liability  to  each 
company  which  undertakes  or  writes  insurance  under 
subdivision  three  of  section  seventy  of  this  act,  whether 
organized  under  this  or  any  other  state  or  country,  a 
further  reserve  as  hereinafter  provided.  For  the  pur- 
pose of  computing  said  reserve,  each  such  company 
which  has  been  engaged  in  liability  underwriting  for 
ten  years  or  more,  shall,  on  or  before  the  first  day  of 
October  in  each  year,  state  in  writing  to  the  superin- 
tendent of  insurance  its  experience  in  the  United 
States,  under  all  forms  of  liability  policies,  each  year 
separately  according  to  the  calendar  years  in  which 
the  policies  were  written,  during  a  period  of  five  years 
commencing  ten  years  previous  to  the  thirty-first  day 
of  December  of  the  year  in  which  the  statement  is 
made,  in  the  following  particulars,  namely:  the  num- 
ber of  persons  reported  injured  under  all  the  forms  of 
liability  policies,  whether  such  injuries  were  reported 
to  the  home  office  of  the  given  company  or  to  any  of 
its  representatives;  the  amount  of  all  payments  made 
on  account  or  in  consequence  of  injuries  reported  under 
such  policies;  the  number  and  amount,  separately,  of 
all  suits  or  actions  against  policyholders  under  such 
policies  which  have  been  settled,  either  by  payment  or 
compromise;  both  of  the  above  amounts  to  be  ascer- 
tained as  of  date  of  the  thirty-first  day  of  August  of 
the  year  in  which  the  statement  is  made,  and  to  include 
in  the  case  of  suits  all  payments  made  on  account  or 
in  consequence  of  the  injury  from  which  the  suit  arose, 

*  Part  of  §86. 


204        Examination  of  Insurance  Companies 

whether  prior  to  or  later  than  the  date  at  which  the 
suit  was  brought.  Each  such  company  shall  thereupon 
reserve  upon  all  said  kind  of  policies,  irrespective  of 
the  date  at  which  the  policies  were  issued  (1)  for  each 
suit  or  action  pending,  on  injuries  reported  prior  to 
eighteen  months  previous  to  the  date  of  making  the 
statement,  whether  such  injuries  were  reported  to  the 
home  office  of  the  given  company  or  to  any  of  its  rep- 
resentatives, and  which  is  being  defended  for  or  on 
account  of  the  holder  of  any  such  policy,  and  the  aver- 
age cost  thereof  as  shown  by  said  experience,  and  (2) 
for  injuries  reported  under  such  policies  at  any  time 
within  eighteen  months,  whether  such  injuries  were 
reported  to  the  home  office  of  the  given  company  or  to 
any  of  its  representatives,  the  average  cost  for  each 
injured  person  as  shown  by  said  experience.  From  the 
sum  so  ascertained  the  company  may  deduct  the 
amount  of  all  payments  made  on  account  or  in  conse- 
quence of  said  injuries  reported  within  eighteen 
months,  this  amount  to  be  taken  as  of  the  date  at 
which  the  statement  is  made.  Any  company  which 
now  issues  or  shall  hereafter  issue,  liability  policies  as 
aforesaid,  and  which  has  not  been  engaged  in  liability 
underwriting  for  ten  years,  shall  nevertheless,  until 
such  times  as  it  may  be  able  to  state  its  experience  of 
the  period  hereinbefore  required,  make  and  maintain  a 
reserve  upon  all  said  kind  of  policies,  irrespective  of 
the  date  at  which  the  policies  were  issued,  determined 
as  follows:  (1)  for  each  suit  or  action  pending,  on  in- 
juries reported  prior  to  eighteen  months  previous  to 
the  date  of  making  the  statement,  whether  such  in- 
juries were  reported  to  the  home  office  of  the  given 


Examination  of  Insurance  Companies         205 

company  or  to  any  of  its  representatives,  and  which 
is  being  defended  for  or  on  account  of  the  holder  of 
any  such  policy,  the  average  cost  thereof  as  shown  by 
the  average  of  said  experience  of  all  other  companies 
stated  as  required  by  this  section,  and  (2)  for  injuries 
reported  under  such  policies  at  any  time  within 
eighteen  months,  whether  such  injuries  were  reported 
to  the  home  office  of  the  given  company  or  to  any  of  its 
representatives,  the  average  cost  for  each  injured  per- 
son as  shown  by  the  average  of  said  experience  of  all 
other  companies  stated  as  required  by  this  section: 
which  average  costs  for  suits  and  for  injured  persons 
shall  be  furnished  by  the  superintendent  of  insurance 
to  each  such  company  on  or  before  the  first  day  of 
December,  in  each  year.  From  the  sum  so  ascertained 
each  such  company  may  deduct  the  amount  of  all  pay- 
ments made  on  account  or  in  consequence  of  said  in- 
juries reported  within  eighteen  months,  this  amount 
to  be  taken  as  of  the  date  at  which  the  statement  is 
made. ' ' 


206        Examination  op  Insurance  Companies 


APPENDIX  K 

(436)  §  512.     Sec.  3. 

**  The  commissioner  of  insurance  shall  compute  the 
reserve  fund  to  be  held  by  such  companies  or  asso- 
ciations by  taking  fifty  percentum  of  the  premiums 
received  upon  all  risks  not  expired  at  the  time  of  mak- 
ing such  computation.  And  in  addition  thereto  in  the 
case  of  corporations  doing  an  employers'  liability  in- 
surance, the  commissioner  of  insurance  shall  compute 
the  liabilities  for  unsettled  claims  in  said  employers' 
liability  insurance  business  at  not  less  than  fifty  per 
cent  of  the  premiums  received  and  earned  during  each 
and  every  year  less  the  amount  paid  for  losses  and  ex- 
penses incidental  thereto,  upon  claims  brought  under 
policies  issued  during  said  year:  Provided,  That  such 
reserve  shall  not  be  compute*d  for  more  than  the  five 
years  previous  to  the  time  of  making  such  computa- 
tion: Provided  further,  That  to  the  amount  of  the 
reserve  so  ascertained,  there  shall  be  added  such 
amount  as  is  necessary  to  provide  for  claims  of  earlier 
date,  not  liquidated." 


Examination  of  Insurance  Companies        207 


APPENDIX  L 

Reserve  for  Unpaid  Liability  Losses 

By  S.  H.  Wolfe. 

The  managers  of  properly  conducted  insurance  com- 
panies are  anxious  to  ascertain  the  present  value  of 
their  future  liabilities,  for  in  no  other  way  can  they 
determine  the  soundness  of  their  underwriting 
methods.  The  method  now  in  vogue  of  computing  the 
present  value  of  future  losses  under  liability  policies, 
as  prescribed  by  the  laws  of  New  York,  Massachusetts, 
Dlinois  and  California,  and  other  States,  is  inadequate, 
is  based  on  incorrect  premises,  and  is  an  aid  to  that 
destructive  and  delusive  process  know  as  '^  fooling 
one's  self." 

The  truth  of  both  of  these  propositions  is  evidenced 
by  the  fact  that  many  companies  voluntarily  charge 
themselves  with  a  greater  loss  reserve  than  they  are 
required  to  do  under  the  afore-mentioned  statutes. 

This  statement  must  not  be  construed  as  an  attack 
upon  the  ideas  of  the  devisers  of  the  laws  which  now 
seek  to  establish  adequate  estimates.  Proper  prin- 
ciples, especially  in  the  insurance  field,  cannot  be  se- 
cured in  one  day,  and  perfected  results  can  only  be 
accomplished  by  gradual  development  and  reformation 
as  the  weak  points  in  our  system  are  revealed. 

With  no  idea,  therefore,  that  I  have  devised  a 
method  original  either  in  its  conception  or  in  its 
method  of  application,  I  nevertheless  submit  the  fol- 
lowing facts  in  order  that  they  may  induce  a  line  of 
thought  which  may  lead  to  the  promulgation  of  a  rule 


208        Examination  of  Insurance  Companies 

of  law  wliicli  will  more  adequately  represent  this  item 
of  the  company's  liabilities. 

In  the  early  summer  of  1907  I  was  requested  by  an 
insurance  department  to  examine  a  company  trans- 
acting a  number  of  kinds  of  business,  among  them  lia- 
bility insurance.  The  application  of  certain  tests  soon 
indicated  that  the  statutes  of  the  various  States  were 
not  requiring  sufficient  reserve  on  unpaid  liability 
losses,  a  conclusion  which  was  verified  by  discussions 
with  the  officers  and  the  fact  that  this  particular  com- 
pany was  charging  itself  with  an  amount  greater  than 
any  statutory  requirement  in  order  to  take  care  of 
these  losses  as  they  might  be  paid.  The  rule  set  down 
by  the  various  insurance  departments  had  been  faith- 
fully adhered  to,  and  it  became  evident  that  the  fault 
was  not  with  its  application  but  with  the  rule  itself. 
It  is  unnecessary  for  me  to  recite  the  methods  speci- 
fied for  the  computation  of  this  reserve,  and  I  shall 
therefore  merely  point  out  those  features  which  will 
indicate  the  incorrectness  of  the  premises. 

The  liability  insurance  policy  probably  gives  greater 
play  for  the  exercise  of  individual  methods  and  judg- 
ment on  the  part  of  the  underwriters  than  any  other 
form.  Even  after  the  premium  is  fixed  and  the  policy 
issued,  the  greatest  latitude  in  the  method  of  carrying 
out  the  terms  of  the  contract  is  allowed.  One  under- 
writer may  consider  it  good  business  policy  to  settle 
his  claims  promptly  and  before  they  are  brought  to 
suit;  another  underwriter  equally  honorable  may  be  of 
the  opinion  that  the  best  interests  of  the  policyholders 
and  stockholders  are  served  by  uniform  resistance  to 
and  deferring  of  loss  payments  until  avoidance  is  no 


Examination  of  Insurance  Companies         209 

longer  possible.  It  is  not  the  function  of  this  discus- 
sion to  decide  upon  the  correctness  or  advisability  of 
one  of  these  attitudes  over  the  other.  But  the  fact 
remains  that  any  method  for  computing  loss  reserves 
under  such  contracts  which  is  based  upon  the  number 
of  suits  filed  or  number  of  notices  received  must  lead 
to  erroneous  conclusion,  for  not  only  will  such  a 
method  be  affected  by  the  divergent  underwriting 
opinions  just  referred  to,  but  it  takes  into  account  the 
mental  calibre  of  the  insured.    To  illustrate: 

One  policyholder  may  feel  it  his  duty  to  notify  the 
company  whenever  one  of  his  employees  receives  a 
scratch  on  the  hand;  some  other  policyholder  may  con- 
sider that  he  will  be  amply  protected  if  he  notifies  the 
company  only  of  such  cases  as  give  evidence  of  prob- 
able loss.  The  actual  disbursements  of  the  liability 
company  under  both  of  these  contracts  may  be  the 
same,  but  under  the  New  York  law,  for  instance,  the 
reserve  for  losses  which  the  company  would  be  re- 
quired to  maintain  on  the  first  policy  would  be  many 
times  the  loss  reserve  required  on  the  second  policy. 
It  is  not  an  unusual  experience  for  a  liability  company 
to  be  required  to  maintain  as  a  loss  reserve  an  amount 
in  excess  of  the  gross  premium  received,  notwithstand- 
ing the  fact  that  it  can  be  conclusively  shown  that  the 
ultimate  loss  under  such  a  policy  is  well  within  the 
underwriter's  expectations. 

The  Michigan  law  is  based  upon  a  different  idea, 
and  seeks  to  establish  as  a  minimum  charge  an  arbi- 
trary percentage  of  the  gross  premiums  received,  with 
the  further  provision  that  this  amount  shall  be  in- 
creased if  the  experience  of  the  particular  company 
14 


210        Examination  of  Insurance  Companies 

shows  that  such  a  course  is  necessary.  The  objections 
to  this  method  are  so  numerous  and  apparent  that  it 
will  be  unnecessary  to  discuss  it,  although  in  justice 
it  may  be  said  that  in  many  cases  the  Michigan  re- 
quirements come  more  nearly  and  closely  to  a  correct 
approximation  of  future  results  than  do  the  other  stat- 
utes referred  to. 

With  the  idea,  therefore,  of  employing  some  method 
which  would  eliminate  the  objectionable  feature  of 
the  two  methods  referred  to,  which  would  furnish  re- 
sults independent  of  the  mental  make-up  of  the  in- 
sured, and  at  the  same  time  take  into  account  the 
underwriting  methods  of  the  management,  the  follow- 
ing method  was  followed: 

From  the  company  records  were  obtained  the  earned 
premiums  applicable  to  the  policies  of  the  various 
years  of  issue.  Referring  to  the  table  hereto  attached 
it  will  be  seen,  for  instance,  that  during  the  first  year 
of  the  policies  issued  during  1896  the  earned  premiums 
amounted  to  $222,599.06.  The  second  year  the  earned 
premiums,  without  additional  premiums  received  as 
the  result  of  pay  roll  audits,  had  increased  to  $483,- 
102.83;  while  the  third  year  indicated  that  additional 
premiums  had  amounted  to  the  insignificant  sum  of 
$700,  and  it  subsequently  developed  that  all  additional 
premiums  were  practically  received  during  the  first 
three  years  of  the  existence  of  the  policy.  In  excep- 
tional cases  the  additions  received  after  that  time 
might  be  safely  disregarded. 

In  the  same  way  the  losses  paid  during  the  various 
years  were  resolved  into  various  groups  representing 
the  years  of  issue.  It  was  found,  for  instance,  that 
$20,182.21  had  been  paid  during  the  first  year  of  the 


Examination  of  Insurance  Companies        211 

policies  issued  during  1896,  $106,132.54  during  the 
second  year,  $68,142  during  the  third  year,  $45,750.09 
the  fourth  year,  $26,017.29  the  fifth  year,  $16,850.37 
the  sixth  year,  $10,725.03  the  seventh  year,  $2,795.69 
the  eighth  year,  $1,993.86  the  ninth  year,  $111.87  the 
tenth  year  and  $226.86  the  eleventh  year. 

In  order  to  provide  a  reasonable  period  of  conclu- 
sion it  was  determined  that  for  the  purpose  of  this 
estimate  it  could  safely  be  assumed  that  all  losses 
would  be  settled  within  ten  years  of  the  issuance  of 
the  policy,  and  such  exceptional  cases  as  ran  beyond 
that  period  would  serve  to  offset  the  interest  factor, 
which  will  be  referred  to  later. 

With  these  facts  in  our  possession  it  was  an  easy 
matter  to  determine  the  ratio  which  the  losses  during 
the  first  series  of  years  bore  to  the  earned  premiums 
of  the  first  series  of  years,  and  in  the  same  way  similar 
ratios  were  determined  for  the  second  to  the  tenth 
years,  inclusive.  The  application  of  these  ratios  to  the 
various  years  became  equally  simple,  and  the  results 
of  such  application  are  shown  in  the  table,  being  indi- 
cated by  the  numbers  contained  within  the  brackets. 
There  are  certain  additional  features  of  the  table  to 
which  it  is  advisable  at  this  time  to  call  attention.  It 
will  be  seen,  for  instance,  that  in  1905  and  1906  it 
became  necessary  to  estimate  the  earned  premiums  as 
well  as  the  losses,  for  it  follows  that  it  is  but  just  to 
allow  a  comj)any  credit  for  its  probable  future  receipts 
as  well  as  for  its  probable  future  disbursements.  These 
estimated  premiums  were  calculated  in  a  similar  man- 
ner as  the  losses.  It  will  be  noted  that  the  space  for 
the  earned  premiums  for  the  second  year  of  the  1906 
business  is  blank,  the  reason  for  this  being  that  as  the 


212        Examination  of  Insurance  Companies 

company  will  be  allowed  full  credit  for  the  total  of  the 
unearned  premiums  at  the  end  of  the  third  year,  it  is 
unnecessary  to  use  an  intermediate  year.  By  this 
means  the  accomplishment  of  our  purpose  by  one  step 
is  made  possible.  In  order  to  arrive  at  the  value  of 
future  losses  on  liability  business,  therefore,  I  summed 
the  loss  figures  shown  in  the  brackets  in  the  table,  and 
deducted  from  this  amount  the  estimated  additional 
premiums  as  shown  in  the  table  (less  the  cost  of  col- 
lection). This  resulted  in  a  slightly  larger  liability 
than  was  assumed  by  the  company,  but  as  I  felt  it 
would  have  been  unjust  to  charge  for  examination 
purposes  this  item  as  computed  in  this  new  and  un- 
tried way,  I  determined  to  wait  until  others  with  more 
experience  at  their  command  could  show  the  correct- 
ness or  incorrectness  of  the  idea  and  suggest  such 
modifications  as  may  be  necessary. 

So  much  for  the  theory.  Quite  recently  the  com- 
pany in  question  completed  its  distribution  of  the 
losses  paid  during  1907,  and  the  following  table  shows 
the  results  of  my  estimates  by  years,  and  alongside  of 
the  actual  payments  that  the  company  made: 

Estimates  Actual 

shown  payments 

PouciES  Issued  in  in  Table         during  1907 

1906   $254,138.40  $268,444.21 

1905 122,718.74  105,230.61 

1904 75,265.48  64,142.59 

1903 50,578.06  33,972.25 

1902 38,549.74  45,937.67 

1901 13,953.59  20,811.24 

1900 5,692.80  7,599.91 

1899 3,450.91  4,401.16 

1898 3,025.71  7,185.47 

Totals $567,373.43      $557,725.11 

The  company,  in  addition  to  the  foregoing,  paid 
losses  during  1907  of  $6,417.44  on  policies  issued  prior 


Examination  of  Insurance  Companies        213 

to  1898,  and  for  which  the  table  makes  no  charge.  It 
will  be  seen,  therefore,  that  my  estimate  differed  from 
the  actual  payments  by  about  $3,000. 

One  of  the  reasons  for  not  discounting  the  future 
payments  was  that  this  factor  could  be  relied  upon 
to  take  care  of  those  extraordinary  disbursements  such 
as  the  $6,417.44  just  referred  to,  and  any  other  for 
which  it  would  be  impossible  to  make  allowance  in  so 
general  an  estimate  as  the  foregoing. 

The  object  of  this  explanation  is  not  to  announce  any 
new  or  unusual  method  or  discovery,  but  to  bring  to 
the  attention  of  practical  underwriters  and  statis- 
ticians a  plan  which  seems  to  me  to  get  rid  of  the 
objectionable  features  of  the  present  laws  and  to  pro- 
vide a  method  which  will  enable  corporations  to  re- 
serve according  to  the  merits  of  their  own  experience. 
If  it  should  become  necessary  to  provide  for  the 
reserve  of  a  company  which  has  not  been  in  existence 
long  enough  to  figure  this  liability  on  its  own  experi- 
ence, it  goes  without  saying  that  a  satisfactory  way 
would  be  to  require  such  a  company  to  reserve  on  the 
basis  of  others  which  have  been  established  for  a 
longer  period.  It  will  likewise  be  noted  that  this  pro- 
posed method,  by  using  the  experience  of  a  number  of 
years  for  the  attainment  of  ratios,  exclusively  deals 
with  the  temporary  or  unusual  fluctuations  which 
might  be  found  in  any  one  year ;  as  the  experience  of 
one  year  disappears  each  year,  it  must  follow  that  we 
will  deal  only  with  the  newest  experience  of  the  com- 
pany. Furthermore,  it  will  be  noted  that  the  losses 
paid  after  the  fifth  year  are  small  in  amount,  and 
therefore  as  the  experience  becomes  ' '  stale  ' '  its  effect 
upon  the  total  result  becomes  smaller. 


214   Examination  of  Insurance  Companies 

experience  table  for  computing  probable  future 

LIABILITY  LOSSES 

Policies  Policies  Policies 

written  written  written 

in  1893  in  1894  in  1895 

Earned  premiums,  first  year $128,716.51  $178,952.65 

Losses,  first  year $3,597.60  16,452.61  16,828.04 

Earned  premimns,  second  year 131,111.33  293,746.21  411,554.77 

Losses,  second  year 37,209.82  51,936.46  75,561.02 

Earned  premiums,  third  year 130,415.65  295,081.10  411,862.79 

Losses,  third  year 16,600.92  44,290.72  69,897.92 

Losses,  fourth  year 13,601.64  33,741.97  50,964.96 

Losses,  fifth  year 12,866.87  13,816.26  20,907.21 

Losses,  sixth  year 14,506.11  9,799.29  14,822.49 

Losses,  seventh  year 2,341.54  8,051.46  7,872.35 

Losses,  eighth  year 2,072.65  3,279.43  631.44 

Losses,  ninth  year 562.00  2,155.07  2,520.70 

Losses,  tenth  year 281.65  1,627.10  1,126.93 

Losses,  eleventh  year 729 .06  1 ,934 .39 

Losses,  twelfth  year 191 .  10  50.00 

Losses,  thirteenth  year 66 .90     

Policies  Policies  Policies 

written  written  written 

in  1896  in  1897  in  1898 

Earned  premiums,  first  year $222,599.06  $295,793.83  $284,368.07 

Losses,  first  year 20,182.21  37,579.17  32,666.49 

Earned  premiums,  second  year 483,102.83  586,291.94  594,604.25 

Losses,  second  year 106,132.54  107,088.75  100,440.84 

Earned  premiums,  third  year 483,829.65  590,330.41  605,141.42 

Losses,  third  year 68,142.00  66,565.30  63,869.17 

Losses,  fourth  year 45,750.09  45,686.41  63,112.33 

Losses,  fifth  year 26,017.29  12,876.94  30,906.79 

Losses,  sixth  year 16,850.37  4,989.56  10,996.67 

Losses,  seventh  year 10,725.03  9,243.83  4,032.34 

Losses,  eighth  year 2,795.69  4,842.58  1,170.10 

Losses,  ninth  year 1,993.80  4,515.46  840.14 

Losses,  tenth  year 111.87  6,487.66  [3,025.71] 

Losses,  eleventh  year .       226 .86  

Policies  Pohcies  Policies 

written  written  written 

in  1899  in  1900  in  1901 

Earned  premiums,  fiirst  year $311,425.63  $343,045.60  $359,952.16 

Losses,  first  year 41,956.85  47,861.66  69,569.61 

Earned  premiums,  second  year 675 ,  136 , 3 1  750 ,  392 . 7 1  840 ,  355 .  93 

Losses,  second  year 110,953.37  153,299.99  201,144.34 

Earned  premiums,  third  year 690 ,  182  .  99  769 ,  297 .  08  888 ,  763 .  98 

Losses,  third  year 97,913.93  106,996.01  78,186.93 

Losses,  fourth  year 44,429.69  56,646.75  48,465.18 

Losses,  fifth  year 39,493.91  39,634.16  41,313.17 

Losses,  sixth  year 45,924.76  18,625.36  38,285.92 

Losses,  seventh  year 4,698.13  15,480.01  [13,953.59] 

Losses,  eighth  year 8,810.90  [5,692.80]  [6,576.85] 

Losses,  ninth  year [3,450.91]  [3,846.48]     [4,443.82] 

Losses,  tenth  year [3,450.91]  [3,846.48]     [4,443.82] 

In  the  above  tables  the  figures  enclosed  in  brackets,  [1,  are  the  estimates  which 

have  been  derived  by  the  methods  set  forth. 


Examination  of  Insurance  Companies        215 


EXPERIENCE  TABLE    FOR    COMPUTING    PROBABLE    FUTURE 
LIABILITY  LOSSES 

Policies            Policies  Policies 

written             written  written 

in  1902             in  1903  in  1904 

Earned  premiums,  first  year $442 ,  924 . 4 1     $450 , 5 1 6 .  06  $426 ,  455 .  79 

Losses,  first  year 95,826.19        81,167.41  80,244.32 

Earned  premiums,  second  year ..  .   1,015,873.50  1,006,676.77  973,278.28 

Losses,  second  year 223,820.84       181,980.79  181,774.41 

Earned  premiums,  third  year 1,073,809.69  1,076,129.44  1,028,216.56 

Losses,  third  year 96,778.83        81,336.44  80,213.41 

Losses,  fourth  year 48,356.05        62,509.26  [75,265.48] 

Losses,  fifth  year 41,092.29       [50,578.06]  [48,326.20] 

Losses,  sixth  year [38,549.74]      [38,633.03]  [36,912.99] 

Losses,  seventh  year [16,858.80]      [16,895.23]  [16,143.01] 

Losses,  eighth  year [7 ,  946 .  19]        [7 ,  963 .  35]  [7 ,  608 .  81] 

Losses,  ninth  year [5 ,  369 .  05]        [5 ,  380 .  65]  [5,141. 09] 

Losses,  tenth  year [5,369.05]       [5,380.65]  [5,141.09] 

Policies  Policies 

written  written 

in  1905  in  1906 

Earned  premiums,  first  year $470,591 .39  $554,324.77 

Losses,  first  year 84,097.77  98,439.31 

Earned  premiums,  second  year 1,086,715.48      

Losses,  second  year 195,400.68  [254,138.04] 

Earned  premiums,  third  year [1,133,137.01]       [1,334,758.61] 

Losses,  third  year [122,718.74]  [144,554.36] 

Losses,  fourth  year [82,945.63]  [97,704.29] 

Losses,  fifth  year [53,257.44]  [62,733.63] 

Losses,  sixth  year [40,689.73]  [47,917.81] 

Losses,  seventh  year [17,790.25]  [20,955.70] 

Losses,  eighth  year [8,385.21]  [9,877.21] 

Losses,  ninth  year [5,665.68]  [6,673.79] 

Losses,  tenth  year [5,665.68]  [6,673.79] 

""  In  the'above'tables  the  figures  enclosed  in  brackets,  [],  are  the  estimates  which 
have  been  derived  by  the  methods  set  forth. 


216        Examination  of  Insurance  Companies 


APPENDIX  M 

''  §  87.  Any  domestic  life  insurance  corporation 
may  accumulate  and  maintain  in  addition  to  an 
amount  equal  to  the  net  values  of  its  policies  com- 
puted according  to  the  standard  adopted  by  it  under 
section  eighty-four  of  this  chapter  a  contingency  re- 
serve not  exceeding  the  following  respective  percent- 
ages of  said  net  values,  to  wit :  When  said  net  values 
are  less  than  one  hundred  thousand  dollars,  twenty 
per  centum  thereof  or  the  sum  of  ten  thousand  dol- 
lars, whichever  is  the  greater;  when  said  net  values 
are  greater  than  one  hundred  thousand  dollars,  the 
percentage  thereof  measuring  the  contingency  reserve 
shall  decrease  one-half  of  one  per  centum  for  each  one 
hundred  thousand  dollars  of  said  net  values  up  to  one 
million  dollars;  one-half  of  one  per  centum  for  each 
additional  one  million  dollars  up  to  ten  million  dollars ; 
one-half  of  one  per  centum  for  each  additional  two 
million  five  hundred  thousand  dollars  up  to  twenty 
million  dollars;  one-half  of  one  per  centum  for  each 
additional  five  million  dollars  up  to  fifty  million  dol- 
lars; one-half  of  one  per  centum  for  each  additional 
twenty-five  million  dollars  up  to  seventy-five  million 
dollars ;  and  if  said  net  values  equal  or  exceed  the  last 
mentioned  amount,  the  contingency  reserve  shall  not 
exceed  five  per  centum  thereof;  provided  that  as  the 
net  values  of  said  policies  increase  and  the  maxi- 
mum percentage  measuring  the  contingency  reserve 
decreases  such  corporation  may  maintain  the  contin- 
gency reserve  already  accumulated  hereunder,  al- 
though for  the  time  being  it  may  exceed  the  maxi- 


Examination  of  Insurance  Companies         217 

mum  percentage  herein  prescribed,  but  may  not  add 
to  the  contingency  reserve  when  the  addition  will 
bring  it  beyond  the  maximum  percentage.  Provided, 
however,  that  nothing  herein  contained  shall  be  con- 
strued to  affect  any  existing  surplus  or  contingency 
reserves  held  by  any  such  corporation  save  that  when- 
ever the  existing  surplus  and  contingency  reserves, 
exclusive  of  said  net  values  and  of  all  accumulations 
held  on  account  of  existing  deferred  dividend  policies 
or  groups  of  such  policies,  shall  exceed  the  limit  above 
mentioned  it  shall  not  be  entitled  to  maintain  any 
additional  contingency  reserve.  Provided,  further, 
that  for  cause  shown  the  superintendent  of  insurance 
may  at  any  time  and  from  time  to  time  permit  any 
corporation  to  accumulate  and  maintain  a  contingency 
reserve  in  excess  of  the  limit  above  mentioned  for  a 
prescribed  period,  not  exceeding  one  year  under  any 
one  permission,  by  filing  in  his  office  a  decision  stating 
his  reasons  therefor  and  causing  the  same  to  be  pub- 
lished in  his  next  annual  report.  This  section  shall 
not  apply  to  any  corporation  doing  exclusively  a  non- 
participating  business." 


218        Examination  of  Insurance  Companies 


APPENDIX  N 

Provision  (6)  of  section  5  of  Act  regulating  the  con- 
ditions and  provisions  to  be  contained  in  policies 
(other  than  the  standard  forms)  of  life  insurance  com- 
panies doing  business  in  Ohio. 

''(6)  A  provision  that  the  policy  shall  participate 
in  the  surplus  of  the  company  and  that,  beginning  not 
later  than  the  end  of  the  third  policy  year,  the  com- 
pany will  annually  determine  and  account  for  the  por- 
tion of  the  divisible  surplus  accruing  on  the  policy, 
and  that  the  owner  of  the  policy  shall  have  the  right 
each  year  to  have  the  current  dividend  arising  from 
such  participation  paid  in  cash  or  applied  to  the  pur- 
chase of  paid-up  additions,  and  if  the  policy  shall  pro- 
vide other  dividend  options,  it  shall  further  provide 
that  if  the  owner  of  the  policy  shall  not  elect  any  such 
other  options  the  dividend  shall  be  applied  to  the  pur- 
chase of  paid  up  additions. 

"  In  lieu  of  the  foregoing  provision  the  policy  may 
contain  a  provision  that  the  policy  shall  participate  in 
the  surplus  of  the  company,  and  that,  beginning  not 
later  than  the  end  of  the  fifth  policy  year,  the  com- 
pany will  determine  and  account  for  the  portion  of 
the  divisible  surplus  accruing  on  the  policy,  and  that 
the  owner  of  the  policy  shall  have  the  right  to  have  the 
current  dividend  arising  from  such  participation  paid 
in  cash,  and  that  at  periods  of  not  more  than  five  years 
such  accounting  and  payment,  at  the  option  of  the 
policyholder,  shall  be  had. 

''  Eenewable  term  policies  of  ten  years  or  less  may 
provide  that  the  surplus  accruing  to  such  policies  shall 


Examination  of  Insurance  Companies        219 

be  determined  and  apportioned  each  year  after  the 
second  policy  year  and  accumulated  during  each  re- 
newal period  and  that  at  the  end  of  any  renewal  period 
on  renewal  of  the  policy  by  the  insured,  the  company 
shall  apply  the  accumulated  surplus  as  an  annuity  for 
the  next  succeeding  renewal  term  in  the  reduction  of 
premiums. 

"  These  provisions  shall  not  be  required  in  non- 
participating  policies." 


220        Examination  of  Insubance  Companies 


APPENDIX  0 

*'  §  97.  Limitation  of  expenses.     No  domestic  life 
insurance  corporation  shall  in  any  calendar  year,  after 
the  year  nineteen  hundred  and  six,  expend  or  become 
liable  for,  including  any  and  all  amounts  which  any 
person,  firm  or  corporation  is  permitted  to   expend 
on  its  behalf  or  under  any  agreement  with  it  (1)  for 
commissions  on  first  year's  premiums,   (2)  for  com- 
pensation, not  paid  by   commission,  for   services  in 
obtaining  new  insurance  exclusive  of  salaries  paid  in 
good  faith  for  agency  supervision  either  at  the  home 
office  or  at  branch  offices,  (3)  for  medical  examinations 
and  inspections  of  proposed  risks,  and  (4)  for  advances 
to   agents,   a   total  amount   exceeding  in  the  aggre- 
gate   (a)    the   loadings   upon  the   premiums  for  the 
first  year  of  insurance  received  in  said  calendar  year, 
(calculated  on  the  basis  of  the  American  experience 
table  of  mortality  with  interest  at  the  rate  of  three  and 
one-half  per  centum  per  annum)  and  (b)  the  present 
values  of  the  assumed  mortality  gains  for  the  first  five 
years  of  insurance  on  the  policies  in  force  at  the  end 
of  said  calendar  year  on  which  the  first  premium,  or 
instalment  thereof,  has  been  received  during  said  cal- 
endar year,  as  ascertained  by  the  select  and  ultimate 
method  of  valuation  as  provided  in  section  eighty-four 
of  this  chapter;  and  (c)  on  policies  issued  and  termi- 
nated in  said  calendar  year  the  full  gross  premiums 
received,  less  the  net  cost  of  the  insurance  for  the  time 
the  insurance  was  in  force,  computed  by  the  American 
experience  select  and  ultimate  table,  three  and  one- 
half  per  centum.    No  such  corporation  shall  make  or 


Examination  op  Insurance  Companies        221 

incur  any  expense  or  permit  any  expense  to  be  made 
or  incurred  upon  its  behalf  or  under  any  agreement 
with  it,  except  actual  investment  expenses  (not  exceed- 
ing one-fourth  of  one  per  centum  of  the  mean  invested 
assets),  and  also  except  taxes  on  real  estate  and  other 
outlays  exclusively  in  connection  with  real  estate,  in 
excess  of  the  aggregate  amount  of  the  actual  loadings 
upon  premiums  received  in  said  year  calculated  ac- 
cording to  the  standards  adopted  by  the  company 
under  section  eighty-four  of  this  chapter,  and  the  pres- 
ent values  of  the  assumed  mortality  gains  hereinbefore 
mentioned.  No  such  corporation,  nor  any  person,  firm 
or  corporation  on  its  behalf  or  under  any  agreement 
with  it  shall  pay  or  allow  to  any  agent,  broker  or  other 
person,  firm  or  corporation  for  procuring  an  applica- 
tion for  life  insurance,  for  collecting  any  premium 
thereon  or  for  any  other  service  performed  in  connec- 
tion therewith  any  compensation  other  than  that 
which  has  been  determined  in  advance.  All  bonuses, 
prizes  and  rewards,  and  all  increased  or  additional 
commissions  or  compensation  of  any  sort  based  upon 
the  volume  of  any  new  or  renewed  business  or  the 
aggregate  of  policies  written  or  paid  for,  are  pro- 
hibited. No  such  corporation  shall  pay  commissions 
upon  renewal  premiums  received  upon  policies  issued 
after  the  year  nineteen  hundred  and  six,  in  excess  of 
five  per  centum  of  the  premium  annually  for  fourteen 
years  after  the  first  year  of  insurance  in  the  case  of 
endowment  policies  providing  for  less  than  twenty  an- 
nual premiums,  nor  in  excess  of  seven  and  one-half  per 
centum  of  the  premium  annually  for  the  first  nine 
years  after  the  first  year  of  insurance  and  five  per 
centum  of  the  premium  annually  for  the  next  ensuing 


222        Examination  of  Insurance  Companies 

five  years  in  the  case  of  other  forms  of  policies;  pro- 
vided that  an  amount  found  to  be  equivalent  to  the 
aggregate  amount  so  payable  by  a  calculation  ap- 
proved by  the  superintendent  of  insurance  and 
based  upon  mortality,  interest  and  lapse  rates, 
may  be  distributed  through  three  or  more  years, 
or  through  a  period  exceeding  fourteen  years,  but  not 
more  than  two-fifths  of  such  amount  shall  be  payable 
for  any  one  year;  provided  further  that  in  any  agency 
district  subject  to  the  supervision  of  a  local  salaried 
representative  the  renewal  commission  payable  to 
agents  of  such  district  shall  not  exceed  two-thirds  of 
the  foregoing  rates  annually  for  fourteen  years,  sub- 
ject to  the  calculation  as  aforesaid;  provided  fur- 
ther that  any  such  corporation  may  condition  the 
allowance  or  payment  in  whole  or  in  part  of  any 
of  the  renewal  commissions  allowed  to  be  paid  as  afore- 
said upon  the  efficiency  of  service  of  the  agent  receiv- 
ing the  same  or  upon  the  amount  and  quality  of  the 
business  renewed  under  his  supervision;  and  also  pro- 
vided that  a  fee  not  exceeding  three  per  centum  may 
be  paid  for  the  collection  of  premiums  which  shall  be 
received  for  any  year  after  the  fifteenth  year  of  insur- 
ance. If  any  such  corporation  shall  compensate  its 
agents,  or  any  of  them,  after  the  first  insurance  year, 
in  whole  or  in  part,  upon  any  other  plan  than  commis- 
sions and  collection  fees,  the  aggregate  sum  so  paid 
shall  in  no  year  exceed  the  limitations  herein  imposed 
and  the  schedule  and  plan  of  such  compensation  shall 
be  submitted  to  and  approved  by  the  superintendent 
of  insurance.  No  such  corporation,  nor  any  person, 
firm  or  corporation  on  its  behalf  or  under  any  agree- 
ment with  it,  shall  make  any  loan  or  advance  to  any 


Examination  op  Insurance  Companies        223 

person,  firm  or  corporation  soliciting  or  undertaking 
to  solicit  applications  for  insurance  without  adequate 
collateral  security,  nor  shall  any  such  loan  or  advance 
be  made  upon  the  security  of  renewal  commissions,  or 
of  other  compensation  earned  or  to  be  earned  by  the 
borrower  except  advances  against  compensation  for 
the  first  year  of  insurance.  A  foreign  life  insurance 
corporation  which  shall  not  conduct  its  business 
within  the  limitations  and  in  accordance  with  the  re- 
quirements imposed  by  this  section  upon  domestic  cor- 
porations shall  not  be  permitted  to  do  business  within 
the  state.  This  section  shall  not  apply  to  expenses 
made  or  incurred  in  the  business  of  industrial  in- 
surance nor,  except  as  to  the  limitation  of  expenses 
for  the  first  year  of  insurance  and  as  to  compensation 
of  and  loans  and  advances  to  agents  or  solicitors,  to 
stock  corporations  issuing  and  representing  them- 
selves as  issuing  non-participating  policies  exclu- 
sively. 


224  EXAMINATIOIT   OF   INSURANCE   COMPANIES 

APPENDIX  P 

Annual  Reports  of  Life  Insurance  Corporations. 

' '  §  103.  In  addition  to  any  other  matter  which  may 
be  required  by  law  or  pursuant  to  law  by  the  superin- 
tendent of  insurance  to  be  stated  therein  every  annual 
report  of  every  life  insurance  corporation  doing  busi- 
ness in  the  state  of  New  York,  made  pursuant  to  sec- 
tion forty-four  of  this  chapter,  shall  contain  an  ac- 
curate, concise  and  complete  statement  of  the  follow- 
ing matters,  to  wit:  (1)  All  the  real  property  held  by 
the  corporation,  the  dates  of  acquisition,  the  names  of 
the  vendors,  the  actual  cost,  the  value  at  which  it  is 
carried  on  the  company's  books,  the  market  value,  the 
amounts  expended  during  the  year  for  repairs  and  im- 
provements, the  gross  and  net  income  from  each  par- 
cel, and  if  any  portion  thereof  be  occupied  by  the  com- 
pany the  rental  value  thereof,  a  statement  of  any  cer- 
tificate issued  by  the  superintendent  extending  the 
time  for  the  disposition  thereof,  and  all  purchases  and 
sales  made  since  the  last  annual  statement,  with  par- 
ticulars as  to  dates,  names  of  vendors  and  vendees, 
and  the  consideration.  (2)  The  amount  of  existing 
loans  upon  the  security  of  real  property,  stating  the 
amount  loaned  upon  property  in  each  state  and  foreign 
country.  (3)  The  moneys  loaned  by  the  corporation 
to  any  person  other  than  loans  upon  the  security 
of  real  property  above  mentioned  and  other  than 
loans  upon  policies,  the  actual  borrowers  thereof,  the 
maturity  and  rate  of  interest  of  such  loans  the  securi- 
ties held  therefor,  and  all  substitutions  of  securities 
in  connection  therewith,  and  the  same  particulars  with 


Examination  of  Insurance  Companies        225 

reference  to  any  loans  made  or  discharged  since  the 
last  annual  statement.  (4)  All  other  property  owned 
by  the  company  or  in  which  it  has  any  interest,  includ- 
ing all  securities,  whether  or  not  recognized  by  the  law 
as  proper  investments,  the  dates  of  acquisition,  from 
whom  acquired,  the  actual  cost,  the  value  at  which  the 
property  is  carried  upon  the  books,  the  market  value, 
the  interest  or  dividends  received  thereon,  during  the 
year;  also  all  purchases  and  sales  of  property  other 
than  real  estate  made  since  the  last  annual  statement, 
with  particulars  as  to  dates,  names  of  purchasers  and 
sellers,  and  the  consideration;  and  also  the  income  re- 
ceived and  outlays  made  in  connection  with  all  such 
property.  (5)  All  commissions  paid  to  any  persons 
in  connection  with  loans  or  purchases  or  sales  of  any 
property,  and  a  statement  of  all  payments  for  legal  ex- 
penses, giving  particulars  as  to  dates,  amounts  and 
names  and  addresses  of  payees.  (6)  All  moneys  ex- 
pended in  connection  with  any  matter  pending  before 
any  legislative  body  or  any  officer  or  department  of 
government,  giving  particulars  as  to  dates,  amounts, 
names  and  addresses  of  payees,  the  measure  or  pro- 
ceeding in  connection  with  which  the  payment  was 
made,  and  the  interest  of  the  corporation  therein.  (7) 
The  names  of  the  officers  and  directors  of  the  company, 
the  proceedings  at  the  last  annual  election,  giving  the 
names  of  candidates  and  the  number  of  votes  cast  for 
each  and  whether  in  person,  by  proxy  or  by  mail. 
(8)  The  salary,  compensation  and  emoluments  re- 
ceived by  officers  or  directors  and  where  the  same 
amounts  to  more  than  five  thousand  dollars  that  re- 
ceived by  any  person,  firm  or  corporation,  with  par- 
15 


226        Examination  of  Insurance  Companies 

ticulars  as  to  date,  amounts,  payees,  and  the  authority 
by  which  the  payment  was  made ;  also  all  salaries  paid 
to  any  representative  either  at  the  home  office,  or  at 
any  branch  office,  or  agency,  for  agency  supervision. 
(9)  The  largest  balances  carried  in  each  bank  or  trust 
company  during  each  month  of  the  year.  (10)  All 
death  claims  resisted  or  compromised  during  the  year, 
with  particulars  as  to  sums  insured,  sums  paid  and 
reasons  assigned  for  resisting  or  compromising  the 
same  in  each  case.  (11)  A  complete  statement  of  the 
profits  and  losses  upon  the  business  transacted  during 
the  year  and  the  sources  of  such  gains  and  losses,  and 
a  statement  showing  separately  the  margins  upon 
premiums  for  the  first  year  of  insurance  ascertained 
according  to  the  select  and  ultimate  method  of  valua- 
tion as  provided  in  section  eighty-four  of  this  chapter 
and  the  actual  expenses  chargeable  to  the  procure- 
ment of  new  business  incurred  since  the  last  annual 
statement  as  enumerated  in  section  ninety-seven  of 
this  article.  A  foreign  corporation,  issuing  both  par- 
ticipating and  non-participating  policies,  shall  make  a 
separate  statement  of  profits  and  losses,  margins  and 
expenses,  as  aforesaid,  with  reference  to  each  of  said 
kinds  of  business,  and  also  showing  the  manner  in 
which  an}^  general  outlays  of  the  company  have  been 
apportioned  to  each  of  such  kinds  of  business.  (12) 
A  statement  separately  showing  the  amount  of  the 
gains  of  the  company  for  the  year  attributable  to 
policies  written  after  December  thirty-first,  nineteen 
hundred  and  six,  and  the  precise  method  by  which  the 
calculation  has  been  made.  (13)  The  rates  of  annual 
dividends  declared  during  the  year  for  all  plans  of  in- 
surance and  all  durations  for  ages  at  entry,  twenty- 


Examination  of  Insurance  Companies        227 

five,  thirty-five,  forty-five  and  fifty-five,  and  the  pre- 
cise method  by  which  such  dividends  have  been  cal- 
culated. (14)  A  statement  showing  the  rates  of  divi- 
dends declared  upon  deferred  dividend  policies  com- 
pleting their  dividend  periods  for  all  plans  of  in- 
surance and  the  precise  methods  by  which  said  divi- 
dends have  been  calculated.  (15)  A  statement  show- 
ing any  and  all  amounts  set  apart  or  provisionally 
ascertained  or  calculated  or  held  awaiting  apportion- 
ment upon  policies  with  deferred  dividend  periods 
longer  than  one  year  for  all  plans  of  insurance  and  all 
durations  and  for  ages  of  entry  as  aforesaid,  together 
with  the  precise  statements  of  the  methods  of  calcula- 
tion by  which  the  same  have  been  provisionally  or 
otherwise  determined.  (16)  A  statement  of  any  and 
all  reserve  or  surplus  funds  held  by  the  company  and 
for  what  purpose  they  are  claimed  respectively  to  be 
held.  (17)  A  statement  showing  all  sums  of  money 
expended  in,  or  in  any  way  connected  with,  the  elec- 
tion of  directors  or  trustees,  with  a  statement  when  ex- 
pended, by  whom  expended,  to  whom  paid  and  for 
what  purpose." 


228        Examination  op  Insurance  Companies 


APPENDIX  Q 

Liability  Loss  Reserves 

By  S.  H.  Wolfe 

I  have  been  asked  by  the  Executive  Committee  of 
this  Association  to  read  a  paper  on  the  subject  of 
'*  Liability  reserves  and  the  effect  of  the  new  Com- 
pensation Law  on  the  question  of  reserve,  with  par- 
ticular reference  to  the  method  of  calculating  the 
latter." 

The  program  of  this  meeting  owes  its  existence  to 
the  enactment  of  certain  laws  bearing  upon  the  pay- 
ments which  employers  are  compelled  to  make  to  their 
employees  in  the  event  of  injuries  to  the  latter  from 
accidental  causes  during  employment.  A  diligent 
search  among  these  statutes  fails  to  reveal  any  men- 
tion of  the  word  ' '  reserves. ' '  The  lengthy  title  of  the 
subject  upon  which  I  have  been  asked  to  address  you, 
indicates,  however,  that  there  is  some  intimate  con- 
nection between  the  two  matters. 

An  idea  which  is  more  or  less  prevalent  (not  only 
among  those  engaged  in  the  liability  business,  but  also 
among  other  underwriters)  is  that  the  reserve  is  in  the 
nature  of  a  penalty  prescribed  by  the  State  or  is  an 
arbitrary  test  created  by  the  same  power  as  a  measure 
of  solvency.  In  reality,  both  of  these  viewpoints  are 
wrong.  If  no  supervising  officer  existed,  if  the  State 
took  no  interest  in  the  progress  of  insurance  com- 
panies and  if  no  laws  designed  to  reveal  the  solvency 
or  insolvency  of  an  insurance  company  had  ever  been 
enacted,  there  would  still  exist  the  necessity  for  the 


Examination  of  Insurance  Companies        229 

creation  and  maintenance  of  a  reserve  fund.  It  is  to 
the  insurance  business  what  the  governor  is  to  the 
steam  engine  —  a  control  to  prevent  self-destruction 
from  abnormal  and  undistributed  operations.  And  as 
the  governor  on  the  steam  engine  is  primarily  in- 
tended for  the  preservation  of  the  engine,  so  is  the  re- 
serve fund  an  absolute  necessity  for  the  insurance 
company. 

The  recognition  and  admission  of  this  idea  will  con- 
vince one  of  the  intimate  relation  between  the  reserve 
fund  and  the  future  history  of  the  corporations  en- 
gaged in  the  business.  I  care  not  how  effectively  or 
how  adroitly  a  company  may  have  delayed  the  enact- 
ment of  proper  legislation  or  may  have  failed  to  prop- 
erly make  the  returns  called  for  by  existing  statutes, 
the  fact  remains  that  unless  a  proper  reserve  liability 
be  maintained,  no  company  can  hope  to  escape  the 
action  of  natural  laws  and  the  penalty  prescribed  for 
their  violation. 

A  great  deal  of  attention  has  been  directed  to  the 
formation  of  some  effective  means  of  calculating  that 
elusive  item  —  the  reserve  for  unpaid  losses.  A  com- 
mittee of  underwriters  connected  with  the  different 
companies  has  been  collecting  data  upon  which  to 
predicate  a  law,  and  has  submitted  a  number  of  plans, 
the  application  of  which  in  most  cases  yields  results 
so  widely  at  variance  as  to  lead  to  the  conclusion  that 
the  basis  of  some  of  them  does  not  rest  upon  proper 
scientific  foundations.  In  the  case  of  one  company  the 
application  of  three  of  these  plans  showed  that  the  loss 
reserve  should  be  as  follows: 

Plan  1  $136,444 

Plan  2  224,038 

Plan  3  209,974 


230        Examination  of  Insurance  Companies 

In  the  case  of  another  the  figures  were: 

Plan  1  $4,097,150 

Plan  2 3,229,880 

Plan  3  3,555,461 

Thus  indicating  widely  divergent  results.  The  great 
danger  in  a  discussion  of  this  kind  is  that  our  earnest- 
ness and  zeal  and  attempt  to  be  absolutely  correct  and 
scientific,  may  cause  us  to  lose  sight  of  certain  essen- 
tials. 

'*  If  once,  the  shadow  to  pursue, 
We  let  the  substance  out  of  view  '* 

we  shall  certainly  fail  to  arrive  at  a  satisfactory  result. 
Kemoving  then,  from  the  question  of  liability  loss 
reserves  any  reference  to  a  State  enactment  or  of  a 
penalty,  and  regarding  them  as  they  should  be,  simply 
in  the  light  of  an  intimate  and  necessary  adjunct  to  a 
company's  affairs  in  much  the  same  way  that  we 
would  regard  its  premium  income  or  its  interest  ac- 
count or  its  officers'  salaries,  we  find  that  the  question 
of  future  losses  is  directly  affected  by  each  of  the  fol- 
lowing factors: 

(a)  The  inherent  worth  of  the  business  —  which 
may  also  be  called  the  underwriting  factor,  since  it  re- 
flects the  skill  and  acumen  of  the  men  in  charge  of  the 
business. 

(b)  The  methods  of  settlement  —  which  may  also  be 
called  the  adjusting  factor,  since  it  represents  the  at- 
titude of  the  officers  who  are  in  charge  of  the  adjust- 
ing department. 

(c)  The  results  of  court  decisions  —  which  may  be 
called  the  litigation  factor. 


Examination  of  Insurance  Companies        231 

(d)  The  general  attitude  of  the  law  makers  —  which 
may  be  called  the  legislation  factor. 

Before  discussing,  however,  the  relative  effect  which 
each  of  these  factors  has  upon  the  total  result,  it  will 
be  advisable  to  refer  briefly  to  the  present  methods  of 
calculating  the  loss  reserves  required  by  the  statutes 
of  the  different  States,  with  particular  reference  to 
their  merits  and  demerits;  it  will  likewise  be  in- 
structive to  notice  to  what  extent  the  different 
methods  take  cognizance  of  the  foregoing  factors. 

Upon  the  statute  books  of  New  York  and  some  of 
the  other  States,  will  be  found  a  method  which  for  the 
sake  of  brevity  we  may  designate  as  ''  the  New  York 
law;"  the  underlying  principle  here  is  the  division  of 
all  future  loss  payments  into  two  broad  subdivisions: 
first,  those  claims  upon  which  suit  has  been  brought 
and  notice  of  the  occurrence  of  the  accident  has  been 
in  possession  of  the  company  more  than  eighteen 
months,  and  second,  those  claims,  the  notices  for  which 
the  company  has  received  within  the  preceding  eigh- 
teen months.  It  is  difficult  to  find  any  merit  in  this 
method  and  its  defects  are  so  glaring  and  so  well 
recognized  that  it  is  unnecessary  for  me  to  consume 
your  time  in  pointing  them  out.  As  long  ago  as  Feb- 
ruary, 1908,  the  writer  prepared  a  paper  which  ap- 
peared in  one  of  the  insurance  journals,  pointing  out 
the  insufficiency  of  this  method ;  the  active  co-operation 
of  the  Insurance  Department  of  the  State  of  New  York 
with  liability  underwriters  in  an  attempt  to  obtain  a 
better  basis,  is  an  indication  of  the  general  recognition 
of  the  insufficiency  of  this  method  of  computing  the 
liability. 

The  second  method  is  in  use  in  one  of  the  States  and 


232        Examination  of  Insurance  Companies 

is  based  upon  the  assumption  that  a  company  will  ulti- 
mately have  to  pay  a  certain  percentage  of  its  pre- 
miums to  policyholders  and  the  unpaid  portion  should, 
therefore,  be  maintained  as  a  liability.  The  merit  of 
this  method  lies  in  that  it  recognizes  the  necessity  for 
the  subdivision  of  the  premiums  and  the  enforced 
segregation  of  those  portions  of  the  premium  income 
which  will  be  used  for  the  payment  of  losses.  Mani- 
festly, however,  such  a  method  fails  to  visit  upon  the 
head  of  the  incompetent  underwriter  a  sufficient 
penalty  for  the  charging  of  too  low  a  premium  and  the 
attempt  of  the  statute  to  guard  against  this  by  placing 
in  the  hands  of  the  Insurance  Commissioners  the  right 
to  increase  the  percentage  in  certain  cases,  is  an  at- 
tempt to  correct  the  evil  by  the  use  of  a  more  objec- 
tionable one,  viz.:  the  clothing  of  an  official  with  dis- 
cretionary power  without  requiring  that  he  be  scien- 
tifically equipped  to  handle  the  situation. 

From  the  foregoing  we  may  conclude  that  neither  of 
the  two  methods  is  satisfactory,  and  we  are  strength- 
ened in  our  belief  by  the  fact  that  the  question  of  lia- 
bility reserves  is  receiving  so  much  attention  at  the 
present  time  with  no  attempt  to  defend  the  two 
methods  or  to  base  future  statutes  upon  them.  The 
companies  have  realized  this  and  in  a  frank,  open  way 
have  asked  the  supervising  officials  of  the  various 
States  to  co-operate  with  them  in  devising  some 
method  of  meeting  this  situation. 

The  effect  of  the  new  workman's  compensation  law 
will  be  far  reaching;  we  know  that  it  will  affect  the 
losses  which  will  be  incurred,  but  we  cannot  say  at  this 
moment  to  what  extent;  we  know  that  it  has  affected 
the  premiums  which  the  assured  will  be  required  to 


Examination  of  Insura.nce  Companies         233 

pay  for  their  protection.  It  will  naturally  follow, 
therefore,  that  the  loss  reserves  must  be  modified  if 
they  are  to  reflect  the  new  conditions.  Manifestly,  the 
ideal  method  of  computing  this  new  liability  will  be 
the  one  which  will  take  into  account  as  many  of  the 
four  factors  which  I  have  previously  mentioned  as  pos- 
sible, and  which  will  assign  to  each  its  relative  weight. 
Let  us  examine  them  in  the  reverse  order  in  which 

they  have  been  stated: 

> 

The  Legislation  Factor 

Who  can  say  what  the  next  day  will  bring  forth  in 
legislation?  We  are  able,  however,  to  observe  fairly 
accurately  the  trend  of  legislation  and  gauge  the  ideas 
which  seem  uppermost  in  the  minds  of  legislators.  The 
defences  upon  which  the  employer  formerly  relied  in 
meeting  an  action  brought  by  an  employee  are  one  by 
one  disappearing  and  the  new  law  on  the  statute  books 
of  New  York  is  undoubtedly  an  entering  wedge  to  a 
system  of  compulsory  compensation,  similar  to  the  one 
now  in  force  in  certain  European  countries.  This  is 
in  line  with  the  advance  of  socialistic  ideas,  so  notice- 
able in  every  avenue  of  human  activity  in  this  country 
as  elsewhere.  New  York  has  placed  on  its  statute 
books  definite  enactments  to  this  end;  a  number  of 
other  States  have  appointed  commissions  to  consider 
the  matter  and  it  is  but  to  be  expected  that  their  re- 
ports when  presented  will  be  largely  influenced  by  the 
completed  action  of  New  York.  It  would  be  the  worst 
kind  of  self-deception  upon  the  part  of  underwriters 
to  assume  that  this  tide  can  be  stemmed.  The  part  of 
wisdom  is  to  drift  with  it  and  to  assume  that  at  this 
moment  it  has  not  yet  reached  its  flood.    The  present 


234        Examination  of  Insurance  Companies 

New  York  Compensation  Act  applies  to  eight  hazard- 
ous occupations  only.  Who  among  us  believe  the  ap- 
plication will  not  be  extended  to  other  fields  of 
activity? 

The  Litigation  Factor 

The  legislators  place  upon  the  statute  books  certain 
acts  dealing  with  the  relations  between  the  employer 
and  the  employee;  the  courts  construe  these  acts. 
Hand  in  hand  with  the  tendency  of  Legislatures  to 
make  it  more  difificult  for  the  employer  to  escape  the 
results  of  accidents  to  his  workmen,  will  be  found  the 
decisions  of  the  courts.  Awards  for  larger  amounts 
have  a  direct  bearing  on  the  subject  of  loss  reserves 
and  this  phase  of  the  situation  must  unquestionably  be 
affected  by  the  definite  amount  of  the  recoveries  speci- 
fied in  the  new  compensation  act. 

The  Adjusting  Factor 

In  the  same  way  that  judicial  awards  are  influenced 
—  unconsciously,  perhaps  —  by  the  arbitrary  stand- 
ards prescribed  by  the  present  workman's  compensa- 
tion act,  so  will  the  question  of  adjustments  be  like- 
wise affected.  Formerly  there  existed  no  basis  upon 
which  an  adjustment  could  be  made;  to-day  the  law 
sets  forth  certain  standards  applicable  to  the  eight 
hazardous  occupations,  and  although  not  applicable  to 
other  cases,  it  enables  the  injured  employee  and  his  at- 
torney to  find  some  official  figure  upon  which  to  base 
his  demand  for  a  settlement.  In  considering  this 
phase  of  the  question,  it  should  likewise  be  borne  in 
mind  that  methods  differ  among  the  various  companies 
transacting   liability   insurance.     In   the   opinion    of 


Examination  of  Insurance  Companies        235 

some  underwriters  the  best  results  are  obtained  from 
prompt  and  early  settlements,  the  others  believe  in 
forcing  a  large  number  of  claims  to  litigation.  If, 
therefore,  we  attempt  to  calculate  the  loss  reserve  upon 
the  basis  of  periods  of  settlement,  we  shall  find  that 
we  are  introducing  an  error  which  will  seriously  affect 
the  scientific  integrity  of  our  calculations. 

The  Underwriting  Factor 

Since  the  premium  is  the  basis  for  all  insurance,  I 
think  I  am  justified  in  assigning  to  this  factor  the 
place  of  chief  importance. 

The  consideration  for  a  liability  policy,  the  pre- 
mium, may  be  properly  divided  into  two  parts:  first, 
that  portion  intended  to  pay  losses  and  loss  expense, 
and  second,  the  portion  intended  to  cover  all  of  the 
necessary  disbursements  of  the  company  —  salaries, 
rents,  dividends,  etc.  With  the  exception  of  the  in- 
terest on  its  invested  assets,  an  insurance  company 
has  no  other  source  of  income.  In  order  to  facilitate 
this  discussion,  I  shall  refer  to  the  first  portion  of  the 
premium  as  ''  the  pure  premium  "  and  to  the  second 
as  "  the  loading." 

The  five  possible  situations  which  we  can  then  have 
are: 

First. —  That  the  pure  premium  is  just  sufficient  to 
pay  the  losses  (irrespective  of  the  date  of  settlement) 
and  the  loading  just  sufficient  to  meet  all  of  the  ex- 
penses; in  this  case  the  underwriting  department  will 
show  that  it  is  self-sustaining  and  the  surplus  will  be 
increased  by  the  interest  received  on  the  investments. 

Second. —  That  the  pure  premium  is  insufficient  to 
pay  the  losses,  but  the  loading  is  sufficient  to  meet  the 


236        Examination  of  Insurance  Companies 

expenses,  in  which  case  the  underwriting  department 
will  show  a  loss,  and  the  increase  or  decrease  in  the 
surplus  will  depend  upon  the  ability  of  the  interest 
income  to  overcome  the  underwriting  deficiency. 

Third. —  That  the  pure  premium  and  the  loading  are 
both  insufficient  to  meet  the  needs  for  which  they  are 
intended,  and  the  increase  or  decrease  in  the  surplus 
in  this  case  will  depend,  as  in  the  second  case,  upon 
the  amount  of  interest  received. 

Fourth. —  That  the  pure  premium  is  in  excess  of  the 
amount  necessary  to  pay  the  losses  and  the  loading 
larger  than  the  expenses  incurred,  in  which  case  the 
surplus  will  be  increased  not  only  by  the  interest  re- 
ceipts, but  also  by  the  excess  in  these  two  factors. 

Fifth. —  That  the  pure  premium  is  in  excess  of  the 
amount  required  to  pay  the  losses,  while  the  loading  is 
insufficient  to  meet  the  expenses;  in  this  event  if  the 
underwriting  profit  and  the  interest  income  are  suffi- 
cient to  overcome  the  deficiency  in  the  loading,  the 
surplus  will  be  correspondingly  increased. 

In  the  foregoing  five  cases  I  have  referred  to  the 
underwriting  profit  not  as  it  is  commonly  understood 
in  the  underwriting  and  investment  exhibit  required 
by  Insurance  Departments,  but  rather  with  particular 
reference  to  the  profits  resulting  from  a  comparison 
of  the  losses  sustained  with  the  pure  premium 
charged. 

I  have  referred  to  these  five  possible  conditions  in 
order  that  we  may  be  led  gradually  to  the  idea  which 
I  have  in  mind,  viz.:  the  derivation  of  the  ''  pure 
premium."  The  ''  loading  "  presents  no  great  diffi- 
culty, for  the  expenses  of  a  company  are  at  all  times 
within  its  control,  and  are  not  subject  to  the  same  dis- 
turbing causes  that  affect  the  other  factor. 


Examination  of  Insurance  Companies        237 

Is  it  possible  to  obtain  a  pure  premium? 

The  law  of  averages  applies  to  liability  insurance  as 
it  does  to  every  other  field  of  activity;  the  practical 
operations  of  insurance  companies  would  be  rendered 
impossible  without  it.  It  will  require  no  demonstra- 
tion upon  my  part  to  prove  that  the  larger  the  number 
of  happenings  exposed  to  observation,  the  more  re- 
liable will  be  the  resulting  statistics,  and  it  seems  to 
me  that  therein  lies  a  solution  for  this  problem;  in 
other  words,  that  a  careful  observation  of  the  practical 
operations  of  the  companies  will  enable  us  to  derive 
the  actual  cost  for  the  various  forms  of  policies,  i.  e., 
the  pure  premium  for  the  particular  hazard.  I  imagine 
that  no  company  in  this  country  has  been  able  by  its 
own  operations  solely  to  accurately  fix  the  cost  for 
each  particular  class;  individual  companies  have  in- 
dividual underwriting  and  adjustment  ideas.  If  we 
were  able,  therefore,  to  obtain  the  experience  of  all 
the  companies  and  correctly  tabulate  it,  we  would 
have  not  only  the  benefit  of  an  extensive  field  of  ob- 
servation, but  in  addition  thereto  we  would  be  able  to 
eliminate  those  conditions  which  I  have  just  pointed 
out,  may  be  peculiar  to  any  one  company. 

Attempts  in  the  past  to  get  the  companies  to  co- 
operate in  the  preparation  of  statistics  of  this  kind 
have  not  been  successful.  It  is  not  my  intention  to 
attempt  to  find  out  why  the  movement  has  not  been  a 
success.  I  am  convinced,  however,  that  failure  must 
inevitably  result  from  an  attempt  to  secure  the  figures 
by  mere  company  agreement.  In  this  emergency  it 
would  appear  that  the  State  could  profitably  and 
properly  step  in  and  require  the  tabulation  to  be  made 
under  its  supervision.    Under  these  circumstances  all 


238        Examination  of  Insurance  Companies 

companies  would  doubtless  be  glad  to  contribute  their 
experience  with  a  full  realization  that  the  details  of 
their  business  would  not  be  exposed  to  the  gaze  of 
competitors,  but  would  be  used  solely  for  the  purpose 
of  deriving  a  factor  which  they  need  for  their  own  pro- 
tection. 

I  am  fully  aware  that  an  objection  against  the  use 
of  ''  pure  premiums  "  derived  from  the  experiences 
of  the  past  will  be  urged.  I  recognize  fully  that  the 
changes  in  the  laws  and  in  the  attitude  of  the  courts, 
which  I  have  pointed  out  a  few  moments  ago,  will 
operate  to  render  those  premiums  more  or  less  insuffi- 
cient, but  ways  exist  for  correcting  this  condition.  In 
the  first  place  the  calculation  would  be  a  continuing 
process,  and  each  year,  therefore,  there  would  be  in- 
troduced a  correcting  factor.  In  the  second  place  it 
would  be  possible  in  my  opinion  to  provide  tempo- 
rarily for  an  arbitrary  constant  which  would  repre- 
sent the  necessary  addition  to  the  pure  premium  ac- 
cording to  the  best  judgment  of  competent  under- 
writers. 

Having  derived  the  pure  premium,  the  procedure  to 
obtain  the  reserve  would  be  as  follows:  The  business 
of  any  calendar  year  would  be  arranged  by  classes 
and  opposite  each  class  would  be  placed  the  pure 
premium  (plus  the  constant)  which  should  have  been 
received  on  the  basis  of  the  standard  experience.  From 
such  net  premium  receipts  would  be  deducted  the  pay- 
ments which  have  been  made  to  policyholders  in  each 
of  the  tabulated  classes.  The  difference  between  the 
premiums  and  the  payments  would  be  the  amount 
which  the  company  should  hold  as  a  reserve  to  take 
care  of  the  future  losses  of  that  class.    As  the  claims 


Examination  of  Insurance  Companies        239 

of  each  year  are  disposed  of  the  reserve  would  auto- 
matically disappear. 

It  will  be  noted  that  the  application  of  this  method 
for  a  number  of  years  will  yield  results  which  will  not 
require  the  use  of  the  arbitrary  constant  referred  to, 
and  it  seems  to  me  that  among  the  advantages  which 
it  possesses  is  the  one  which  removes  from  the  con- 
sideration of  the  loss  reserve,  the  premium  which  was 
charged  to  the  insured;  rates  made  in  competition, 
therefore,  cease  to  be  a  disturbing  factor  in  this 
method  of  calculation. 

I  have  attempted  to  show  that  the  premium  is  the 
substance  and  the  loss  reserve  is  the  shadow;  if  the 
premium  be  once  derived  by  safe,  sane  methods,  loss 
reserves  will  take  care  of  themselves.  The  derivation 
of  the  premium  in  the  manner  outlined  will  enable  the 
State  to  insist  that  no  premium  lower  than  the  recog- 
nized minimum  rate  shall  be  charged  by  any  company. 
Similar  action  is  now  enforced  by  the  State  in  its  super- 
vision of  life  insurance  companies,  for  if  one  of  these 
companies  should  use  premiums  less  than  those  pre- 
scribed by  the  tables  of  mortality  and  interest  fixed  by 
the  State  as  a  minimum  standard,  it  is  visited  with  a 
penalty  in  the  shape  of  additional  reserves  and  the 
penalty  has  proven  to  be  severe  enough  to  deter  any 
company  from  following  a  course  which  in  the  opinion 
of  the  State  would  be  unsafe. 

The  method  suggested  above  would  entail  no  hard- 
ship upon  the  well  managed  company;  if  the  minimum 
rate  should  be  higher  than  that  required  by  its  careful 
underwriting,  the  difference  would  be  temporarily  car- 
ried in  its  loss  reserve  and  ultimately  find  its  way  into 
its  surplus. 


240        Examination  of  Insurance  Companies 

To  summarize,  I  would  say  that  in  my  opinion  the 
new  compensation  law  will  have  a  decided  effect  upon 
the  loss  ratio  of  the  companies,  and  therefore,  upon 
the  question  of  reserves  which  should  be  maintained 
for  the  unpaid  losses.  For  the  method  suggested 
above,  no  originality  is  claimed,  for  the  idea  must  have 
been  in  the  minds  of  practical  underwriters  for  some 
time.  If,  however,  I  have  succeeded  in  making  the 
necessity  for  concerted  action  in  this  direction  more 
apparent  to  you,  I  feel  that  I  have  accomplished  the 
purpose  of  my  talk. 


INDEX 


[241] 


INDEX 


PAGE. 

Accident  companies,  method  of  treating  outstanding  losses  in ... .  94 

Accounts  of  insolvent  debtors  in  credit  companies 106 

Accrued    interest    53 

Accumulation  factors 77 

Administrators'    bonds 98 

Advance  premiums 117 

Advisory    Board    contracts 116,  144 

Agents'  balances  in  fire  companies 55 

Agents'  balances  in  life  companies 54 

Agents'  debit  balances 54 

Amortization    70 

Amortization  of  bonds  with  redemption  privileges 79 

Amortization,  unscientific  approximation  of 78 

Annual  statements,  paid-for  basis 61 

Annual   statements,   written  basis 61 

Annuities  certain    91 

Annuity  claims  unpaid 93 

Annuity  payments    142 

Appeal  bonds   98 

Application   of   schedules   to   annual   statement 167 

Appreciation   in   assets    allowed 69 

Assets,  appreciation  in,  allowed 69 

Assets,  non-admitted    64 

Attitude   of   examiner 11 

Bills  of  lading,  guaranty  for 179 

Bills  receivable    53 

Bonds     30 

Bonds,  amortization  of 70 

Bonds,  coupon    36 

Bonds,   depreciation   in 68 

Bonds,  government    30 

Bonds,  industrial    32 

Bonds,  irrigation     32 

Bonds,  municipal    31 

Bonds,  public  service   32 

Bonds,  railroad    32 

Bonds,  registered     36 

Bonds,  state     31 

[243] 


244  Index 

PAGE. 

Bonds,  with  redemption  privileges,  amortization  of 79 

Book  value  of  ledger  assets  over  market  value 68 

Borrowed  money  120 

Capital  stock   121 

Capital  stock  may  not  be  used  for  establishing  business 65 

Capital  stock  owned    65 

Cash   advanced  to   officers 66 

Cash,  certificate  for  checking  deposits  of 47 

Cash  in   bank 46 

Cash   in   office 46 

Cash,  percentage  which  should  be  held 46 

Classification  of  fidelity  and  surety  risks 163 

Collateral  loans    42 

Collateral  loans,  insufficiency  of  collateral  deposits  protecting. ...  68 

Commuted   commissions    66 

Companies'   own  occupancy 20 

Contingency  reserve    95,  125 

Contractors'  bonds   98 

Co-surety    102 

Credit  companies,  accounts  of  insolvent  debtors  in 106 

Credit  companies,  unearned  premiums  of 107 

Credit  insurance  policy,   definition  of 104 

Credit  insurance,  special  liabilities  applicable  to 104 

Credit  policies,    limitation   of   risk  on 183 

Credit    policies,    limits    of   risks 113 

Death  claims,  liabilities  on  account  of 92 

Death    losses    resisted 93 

Deferred  dividend  policies 128 

Deferred   premiums    57 

Deferred   premiums,  loading  on 63 

Depository   bonds    102 

Depreciation  in  bonds 68 

Depreciation  in  mortgages 68 

Depreciation  in  real  estate 68 

Depreciation  in  stocks 68 

Directors  not  to  be  interested  in  sales  or  purchases 36 

Dividend  liabilities  of  life  insurance  companies 124 

Dividends    143 

Excess  credit  66 

Excess    interest   earnings 130 

Excise   bonds    98,  175 

Excise  Reinsurance  Association 176 


Index  245 

PAGE. 

Fidelity  policies,  method  of  checking  issuance  of 100 

Fidelity  policy,  definition  of 98 

Fidelity  risks    classified 163 

Fire  insurance  premiums  paid  in  advance 54 

Fire  losses    97 

Fraternal  organizations,  uncollected  premiums  in 62 

Fraternals,  additional  schedule  for 158 

Furniture  and  fixtures 53 

General  rules  for  examinations 134 

Guaranteed  certificates    179 

Guaranty  of  bills  of  lading 179 

Guardians'  bonds    98 

Health  companies,  method  of  treating  outstanding  losses  in 94 

Installment  payments    142 

Installment  policies    89 

Interest  accrued    53 

Interest,  effective  rate  of 79 

Interest  on  policy  loans  paid  in  advance 50 

Investments    16 

Ledger  assets,  book  value  of,  over  market  value 68 

Liability  companies,  loss  reserves  of 112 

Liability  companies,  special  reserve  for  unpaid  losses 109 

Liability  losses,  different  methods  of  settling 110 

Liability  policy,  definition  of 109 

Liability  policy  differs  from  Workmen's  Collective  policy 110 

Liability  policies,   limitation   of   risk   on 183 

Liability  policies,   limits   of   risks 113 

Liens  given  when  policies  are  changed 51 

Liens  of  reorganized  assessment  companies 50 

Liens,  sources  of 50 

Life  insurance  companies,  liabilities  on  account  of  death  claims  of.  92 

Life  insurance    losses 142 

Life  insurance  policies,  net  value  of 80 

Life  insurance  policies,  reinsurance  credits  on 87 

Limitation  of   risk 181 

Limitation  of  risk  on  credit  policies 183 

Limitation  of  risk  on  liability  policies 183 

Limits    of    risk 113 

Loading  on  uncollected  and  deferred  premiums 63 

Loans  on  collateral   42 

Loans  on  policies    44 

Losses  due  and  unpaid 92 


246  Index 

PAGE. 

Losses  in  life  insurance  companies 142 

Losses  in  process  of  adjustment 92 

Losses,    reinsurance  on    95 

Losses  reported,  no  proofs  received 93 

Losses  under  liability  policies,  different  methods  of  settling 110 

Loss  reserves  for  liability  companies 112 

Maintenance  bonds   98 

Marine  companies,  unearned  premiums  of 86 

Matured  endowments  due  and  unpaid 93 

Mean    reserve     81 

Miscellaneous   liabilities    115 

Mortgagee    clause,    fire    policies    on    mortgaged    property    should 

contain    25 

Mortgages    22 

Mortgages,  abstract  of  title  of 24 

Mortgages,  appraisal  of   25 

Mortgages,  depreciation  in 68 

Mortgages,  guaranteed 27 

Mortgages,  margin  of  safety  in 22 

Mortgages,  notice  of  interest  due  on 27 

Mortgages  on    unimproved    property 25 

Mortgages,  partial  payments  on 23 

Mortgages,  purchase-money   26 

Mortgages,  recording  tax  on 24 

Mortgages,  second  mortgages  not  permitted 24 

Mortality  savings   130 

Net  terminal  value    81 

Net  value  of  life  insurance  policies 80 

New  York  excise  risks 175 

Non-admitted   assets    64 

Non-participating  policies   124 

Officers  not  to  be  interested  in  sales  or  purchases 36 

Over- statement  of   disbursements 136 

Paid-for  basis    138 

Participating   policies    124 

Perpetual  policies  87 

Plate  glass  losses 97 

Policies  in  hands  of  agents 184 

Policyholders'  basis    137 

Policy  loans   44 

Policy  loans,  interest  on,   paid  in  advance 50 

Policy  loans,  unearned  interest  on 118 


IiTOEX  247 

PAaE. 

Policy  loans,  verifying  schedule  of 48 

Premium  notes    , 52 

Premium  on  capital  stock 139 

Premiums  deferred   57 

Premiums  in   course  of  collection 56 

Premiums  on   bonds,   improper  method   of  treating 72 

Premiums  paid   in   advance 117 

Premiums,  semi-annual   and  quarterly 58 

Premiums  uncollected    60 

Profit  and    loss  account 148 

Quarterly   premiums    58 

Real  estate   16 

Real  estate,  abstract  for    17 

Real  estate,  appraisal   of    19 

Real  estate,  deed  for   17 

Real  estate,  depreciation   in    68 

Real  estate,  division  of  examination  of 17 

Real  estate,  fire  insurance  policies  protecting 21 

Real  estate,  limitations  in  regard  to  owning 16 

Real  estate,  may  only  be  held  for  limited  time 21 

Real  estate,  method  for  arriving  at  market  value  of 19 

Referees'  bonds   98 

Reinsurance  credit  for  life  policies 87 

Reinsurance  on  losses    95 

Reinsurance  on  losses  due   54 

Reinsurance  should  be  taken  into  account   in   calculation   of  un- 
earned  premiums    87 

Rents  paid   in  advance 54 

Resisted  claims,  method  of  treating 93 

Resisted  death    losses    93 

Sale  of  capital  stock  to  policyholders  forbidden 122 

Salvage     101,  143 

Savings  from  loadings 130 

Schedules    149 

Semi-annual  premiums    58 

Sources  of  dividend  earnings 130 

Special  contracts    116,  144 

Special  liabilities    104 

Special  liabilities  applicable   to   credit   insurance 104 

Special  reserve  for  unpaid  losses  of  liability  companies 109 

Standard  forms  of  life  insurance  policies 126 

Stock  of  similar  corporation  may  be  bought  by  surety  companies . ,  42 

Stocks    38 


248  Index 


PAGE. 


stocks,  common    40 

Stocks,  depreciation  in   68 

Stocks,  guaranteed   41 

Stocks,  life  insurance  companies  not  permitted  to  invest  in 40 

Stocks,  preferred    40 

Supervision,  history  of 9 

Surety  bonds,  definition  of 98 

Surety  bonds,  method  of  checking  issuance  of 100 

Surety  risks    classified    163 

Supplies,  stationery  and  printed  matter 66 

Supply   bonds    98 

Surplus    123 

Surrender   values    143 

Surrender  values  claimable 91 

Tax  lien,  transfer  of 28 

Title  insurance   18 

Tontine  policies    128 

Unassigned  funds   123 

Uncollected  premiums    60 

Uncollected  premiums  in  fraternal  organizations 62 

Uncollected  premiimis,    loading    on 63 

Under-statement   of   receipts 136 

Unearned  interest  on  policy  loans 118 

Unearned  premium  account  not  scientifically  computed 82 

Unearned  premiums  of  credit  companies 107 

Unearned  premium  of  fire  company,  method  of  verifying 185 

Unearned  premiums   of  marine   companies 86 

Unearned  premiums  on  pro  rata  basis 83 

Unpaid  annuity  claims 93 

Voluntary  reserve 95 

Voucher-cheques    141 

Window  dressing   44 

Workmen's   Collective  policy  diflFers   from  liability  policy 110 

Workmen's  Compensation  Act,  probability  of Ill 

Written  basis 138 


CFTME  \ 

UNIVERSSTY  ) 

OF  JJ 


THIS  BOOK  IS  DUE  ON  THE  LAST  DATE 
STAMPED  BELOW 


AN     INITIAL     FINE     OF     25     CENTS 

WILL  BE  ASSESSED  FOR  FAILURE  TO  REn"URN 
THIS  BOOK  ON  THE  DATE  DUE.  THE  PENALTY 
WILL  INCREASE  TO  50  CENTS  ON  THE  FOURTH 
DAY  AND  TO  $1.00  ON  THE  SEVENTH  DAY 
OVERDUE. 


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